22
Jul
This article from The Economist is a must read. It explains how the United States got into this mess and the implications it faces now that its financial system is unraveling. The article draws the conclusion that Paulson’s current plan would essentially turn FNM and FRE into a printing press. The alternative would be to nationalize the companies, which would transfer huge sums of debt onto the governemnt’s balance sheet. Either way, the US dollar will weaken further. The article’s last sentence reads, “Perhaps it is no surprise that traders in the credit-default swaps market have recently made bets on the unthinkable: that America may default on its debt.”
I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Tim Ramsey
‘That suggests yet another irony; the debt of the GSEs has been trading as if it were guaranteed by the American government, but the debt of the government was not trading as if Uncle Sam had guaranteed that of the GSEs.’
- That is correct. There is no premium in the treasuries at this time.
“The companies have also been unwilling to accept the pain of market prices in acknowledging delinquent loans. When borrowers fail to keep up payments on mortgages in the pool that supports asset-backed loans, Fannie and Freddie must buy back the loan. But that requires an immediate write-off at a time when the market prices of asset-backed loans are depressed. Instead, the twins sometimes pay the interest into the pool to keep the loans afloat. In Mr Rosner’s view, this merely pushes the losses into the future.”
- This requires more detail then what has been published. A delinquent loan is NOT a foreclosure that needs to be written off at a depressed price. Paying the interest on a delinquent loan dopes indeed push the problem into the futire, but it far less costly than incurring the loss of the loan at a depressed price. The majority of delinquent loans do NOT go into foreclosure
The best thing Congress, considering the government is potentially on the hook for it, can do is to look into the levels of leverage that these companies were allowed to amass. Improper leverage is the predominant problem in almost every bubble that has been created dating back to 1929.
In the end, the turtle at the bottom of the pile is the American taxpayer. But that suggests that, if Americans are losing money on their houses, pensions or bank accounts, the right answer is to tax them to pay for it. Perhaps it is no surprise that traders in the credit-default swaps market have recently made bets on the unthinkable: that America may default on its debt.
- The problem with this thinking, and what this article doesn’t consider, is that aggregate housing prices will at some point, probably sooner rather than later, stabilize. Some areas already have, and areas that saw unsustainable price appreciation such as CA, NV, FL will eventually have to bottom. When that happens the at risk loans that need to be written off will stop depreciation of the loan portfolio. It’s not going to be the end of the world.