Brave New World

September 8, 2008 at 12:39 pm  ·  Category: Macro Economics, Market Commentary

Under these agreements, Treasury will ensure that each company maintains a positive net worth.

- Statement by Treasury Secretary Paulson on the bailout of Fannie Mae and Freddie Mac

If anybody thought we had a pure free market system, they should think again.

- Robert Bruner, Dean of The Darden School of Business at The University of Virginia

Things fall apart; the centre cannot hold.

- WB Yeats, “The Second Coming”

The federal government bailout of Fannie Mae and Freddie Mac marks the culmination of two months of speculation and concern over the GSEs and the systemic risk they posed to the global financial system. 

More broadly, it is a significant event in financial and economic history.  Analysts and historians will debate it for years.  Books will be written about it.

The Treasury, acting in conjunction with the Fed, finally came to the conclusion that some have held for years: Fannie and Freddie are bankrupt.  That is, the mortgages and mortgage backed securities they own are not worth as much as the debt they owe and the guarantees they’ve made.

This is no small matter.  Fannie and Freddie have $1.6 billion in debt held by central banks, financial institutions and investors the world over.  They own or guarantee $5 trillion worth of mortgages and mortgage backed securities.  Their insolvency would result in massive losses across the globe and probably a worldwide financial crash.

According to a front page Wall Street Journal article this morning, Morgan Stanley analysts told Treasury officials on the morning of August 18th that the two companies were as much as $50 billion in the hole.  It will probably amount to much more than that by the time it’s all said and done.

The government faced a choice between a massive amount of pain and an embarrassing and expensive bailout.  It wasn’t hard to foresee which one they would choose.

I’m still trying to wrap my mind around the enormity of this event.  All day I can’t help but thinking: “I can’t believe this is happening.  I can’t believe this is happening.”

Many years ago a friend of mine with a Master’s Degree in Economics described the structure of the global economic system as “surreal” – with an eye towards just this type of apocalyptic event.

*****

There’s always soma to calm your anger, to reconcile you to your enemies, to make you patient and long-suffering. In the past you could only accomplish these things by making a great effort and after years of hard moral training. Now, you swallow two or three half-gramme tablets, and there you are. Anybody can be virtuous now. You can carry at least half your morality about in a bottle. Christianity without tears-that’s what soma is.

- Aldous Huxley, Brave New World

The financial equivalent of soma is paper money.  Housing market collapsing?  Just lower interest rates to stimulate economic activity.  Economy going into recession?  Send out stimulus checks to get people to spend.  Huge financial institutions going under?  Just take them over and pay for it by printing more money.

Those who desire clarity and understanding might wonder about the long term side effects.  Where does all this money come from?  Is there really a free lunch?

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

- John Maynard Keynes, The Economic Consequences of the Peace, Ch. 6

Judgment day is that much closer after today.  Not one man in a million.  Can you hear me Ludwig von Mises?  Can you hear me?

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Fannie and Freddie
Read more on Fannie Mae, Freddie Mac, 2008 Financial Crisis at Wikinvest
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3 Responses to “Brave New World”
  • [...] – Robert Bruner, Dean of The Darden School of Business at The University of Virginia [h/t Top Gun FP] [...]

    American Comintern | Condor Options  ·  Sep 9, 2008 at 11:29 am  ·  Permalink
  • [...] The government takeover of Fannie Mae and Freddie Mac will have far-reaching economic effects.  For example, hedge funds that bet against the two companies have already seen windfall profits as the stock prices of both companies plummeted over the weekend, while the financial institutions that invested in the nearly $5 trillion in mortgages and mortgage-backed securities that FNM and FRE guarantee can breathe a sigh of relief.  The government bailout should help avoid a global financial crisis – but it might not help all of the Real Estate Investment Trusts (REITs) that depend on loans from Fannie and Freddie to finance their growth. [...]

  • [...] The government takeover of Fannie Mae and Freddie Mac will have far-reaching economic effects. For example, hedge funds that bet against the two companies have already seen windfall profits as the stock prices of both companies plummeted over the weekend, while the financial institutions that invested in the nearly $5 trillion in mortgages and mortgage-backed securities that FNM and FRE guarantee can breathe a sigh of relief. The government bailout should help avoid a global financial crisis – but it might not help all of the Real Estate Investment Trusts (REITs) that depend on loans from Fannie and Freddie to finance their growth. [...]

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