Busted: Bankers and The Global Economy

July 10, 2008

Foreclosures Threaten to Consume Economy

Lately, it has been a cruel world for home buyers and banker types alike. The grim cloud of foreclosure hangs in the air like a dark panic. Today, politicians, Wall Street and media pundits spoke about what would happen if Fannie Mae and Freddie Mac were to collapse, revealing the fact that they are already effectively bankrupt. The fact that the president is openly discussing the plight shows the seriousness of the matter, even though he suggests that the potential of such a collapse is remote at best. The administration suggested that avoiding a collapse through the necessity of bailing out the government mortgage houses would create a U.S. economic depression.

343,159 Americans lost their homes, jumping from 145,696 recorded during the same period in 2007. Some states have recently put a moratorium on foreclosures. The president and Congress are working on a bill to refinance a large chunk of mortgages, effectively bailing out the troubled system and flailing home buyers.

There is little help within the system itself. Banking self-interest is keeping mortgage servicers from avoiding foreclosures. Mortgage servicers do not want to affect the value or take the huge amount of time necessary to rewrite mortgages, which would result in losses to investors on securitized loans. The bottom line is that not enough manpower is available to reanalyze and reissue new loans. Streamlining processes has proved to be virtually impossible in reversing the damage according to mortgage insiders.

Obviously, the lives of bankers, mortgage servicers and investors don’t depend on efficiency or they would be motivated. Since the government is working on a bailout plan which will be charged to taxpayers and the increasing national debt, mortgagers and investors alike are expecting a large bailout. As a result, there is little fire in their belly to get things moving along. Excuses are much easier.

In the event of collapse, shareholders could have their holdings wiped out, even with a federal bailout. As a result, confidence and stock prices have plunged, making a financing disaster more likely as raising more capital to cover losses will be harder than ever.

In the meantime, investment bankers are relieved not to be topic of conversation and conjecture. They are focusing on a doomsday failure scenario to get their minds off of their own financial problems. A failure of these institutions along with the resulting bailout would be a good thing for many investment bankers, a win-win situation. The would plan on being bailed out and the huge economic albatross would draw attention from their mistakes and crimes.

The Federal Reserve and the Treasury have taken great pains to point out that the government is not obliged to bail out either Fannie or Freddie if they face insolvency. That is a straw dog if there ever was one. As a practical matter, the government can’t let these institutions fail because they are being counted up on to help fix the mortgage mess. If Fannie and Freddie were unable to buy and back loans, banks would stop originating them, the pool of homebuyers would shrink and home prices would plummet. The U.S. government would need to create a new means to administer any mortgage bailout.

Senator and presidential candidate John McCain disclosed today: “They will not fail. We cannot allow them to fail. They are vital to Americans’ ability to own their own homes and we will do what’s necessary to make sure that they continue that function.” Fellow senators are likely to agree, especially since this debacle threatens their livelihood.

Financial Armageddon isn’t so difficult. Fannie and Freddie are underfunded or “highly leveraged”. Fannie and Freddie must constantly borrow money in order to operate. If borrowing costs rose sharply they would not be able to make good on their guarantees or even fund their day to day operations. This is when the government would feel intense pressure to step in and, at the very least, pay contracts in a timely manner. Since they guarantee half the loans in the country, the problem becomes glaringly obvious. Still, as the geniuses at Lehman purport, the chances of a disaster are very unlikely.

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