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The Fannie Mae and Freddie Mac Farce


If we don't change course, March 2008 will look like a picnic.

Last night Bloomberg printed an article about Fannie Mae (FNM) and Freddie Mac (FRE). Here are the lowlights:

1. There were 2.6 million defaults on residential mortgages in the first nine months of 2009;

Fannie Mae recorded $101.6 billion in losses over the past eight quarters;

Fannie Mae has taken $44.6 billion of Federal Aid since April 2009;

Fannie Mae now says it needs $15 billion more in Federal Aid (which makes sense, as $45 billion simply won't do);

Freddie Mac has borrowed $50.7 billion from the government since November 2008;

Fannie Mae had a negative net worth of $15 billion as of September 30, 2009.

Pretty impressive, right? Well, it gets worse. Apparently, our government thinks the Fannie/Freddie experiment is working, despite obvious evidence to the contrary. Need proof? For starters, the $8,000 tax credit for home buyers was extended from November to April 2010.

Now, the support of Fannie and Freddie is literally sustaining the housing market at current prices. Together, Fannie and Freddie now guarantee 20% of the $12 trillion (that is Trillion with a capital "T" -- does anybody have the slightest idea how much money that is?) of residential mortgages in this country. That tab is on us, folks -- $2.4 trillion.

Further, Fannie and Freddie, taken together, account for 70% of all new mortgages. Coupled with the FHA's 20%, the government-backed percentage of the mortgage market comes to 90%. 90%! That tells any sane person that there's no residential housing market at current prices.

The definition of insanity is doing the exact same thing over and over again, and expecting different results. We tried the Fannie/Freddie thing. They were quasi-government entities. They took their part in the biggest credit bubble in history. Remind me, how did that end up? Didn't Barney Frank and Chris Dodd assure us everything would be okay? Amazingly, not only do Frank and Dodd still have jobs, but they're at it again.

Today, the only difference is we have an explicit guarantee. But we're not writing better paper; the problem -- far from being solved -- is getting worse, not better.

The numbers laid out above demonstrate very clearly the degree of distortion in the markets provided by the government. Put simply, people cannot afford current housing prices. Not to worry -- our Government will fudge the prices. But that's a real cost. Real to the tune of hundreds of billions -- even trillions -- in actual losses, funded by, and the responsibility of, the taxpayers. And this doesn't take into account the tax credits, which are being extended.

So this is nothing more than a transfer of wealth, orchestrated by Uncle Sam. To protect the existing prices of houses, and to enable a minority of the population to have homes they cannot afford, the government has extracted a huge price from the balance of the population. The way I see it, I'm paying for many of my neighbors' homes. How should I feel about that?

There's one -- and only one -- rational solution. That is, to let prices clear, no matter how low they go. We refuse to take our medicine. Buyers will emerge at low enough prices. True, families will be wiped out, homes will be virtually given away. But that creative destruction is the essence of our system. It must not be tampered with. Let Fannie go begging.

History doesn't look kindly on the current tampering we're experiencing. Look at the 1930s, Japan over the last 20 years, or the US airline industry. In each case, the treatment for the disease became worse than the disease itself. More unsustainable leverage at higher prices can hardly be the cure for unsustainable leverage at higher prices.

Let house prices go where they may. Let individuals and Institutions bear the rewards -- or pain -- of their decisions. Let the market clear. We may think we can tamper with mother nature, but we can only do so for a while. Sure, today's rally feels good. Eventually, reality sets in. When it does, unless we change course, March 2008 will look like a picnic.
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