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Friday, May 21, 2010

Another FRE and FNM Bailout

Fannie Mae (FNM) and Freddie Mac (FRE) are in the news again. They're still losing money. They got another infusion of Federal bailout money.

FRE and FNM get a legal perk that no other business gets. Their debt is backed by the Federal government. This means they get to borrow for slightly more than the Treasury rate. This cheap money must be used to buy mortgages and mortgage CDOs. Executives at FRE and FNM maximize their profits by issuing as many mortgages they can.

If I wanted to start my own mortgage financing business, I could not profitably compete with FRE and FNM. Their State-granted perk is too valuable. Even for other mortgages, I wouldn't have a profitable lending business unless I had a State bank license. The Federal Reserve credit monopoly keeps interest rates artificially low. This prevents individuals from profitably lending each other money.

The only way I can get $1000 is by actually working for it. When a bank lends money, they literally print and lend brand new money.

If I lend you money at 6%, that's a bad deal for me. I'll get ripped off by inflation. I'd be better off buying gold. If I lend you money at the true inflation rate of 20-30%, then the borrower gets ripped off. Why would you borrow from me at 20%-30% when you can borrow at 6% from a State bank? Similarly, the borrower would be foolish to accept a loan with a "gold clause". The implied interest rate would be too high.

Even a mortgage trader at Goldman Sachs cannot profitably compete with FRE and FNM. Goldman Sachs may borrow cheaply, but only at the overnight Fed Funds Rate. A trader who borrows at the Fed Funds Rate to buy mortgage bonds can lose if the Federal Reserve cartel raises interest rates by more than expected. Some people say that the housing crash was exacerbated when the Federal Reserve kept the Fed Funds Rate at 5.25% a few years ago. That was Cramer's famous "They know nothing!" rant, demanding lower interest rates.

If you borrow at 3% to buy mortgages yielding 6%, your profit rate is 3% times your leverage, typically 30x-100x+. If you borrow at 5.25% to buy mortgages yielding 6%, there's very little margin for error, especially when borrowers start defaulting.

The trader at Goldman Sachs borrows at the Fed Funds Rate. The mortgage trader at FRE or FNM borrows at the Treasury term rate. This makes it easier for the trader to balance the cashflow and hedge interest rate risk. If the mortgage will take 10 years to be repaid on average, then the trader at FRE or FNM issues a 10 year bond. This is nearly a perfectly hedged position, except for the risk of mortgage defaults. The trader at another bank can't do the same thing, because he may only borrow at the overnight Fed Funds Rate. If a bank issues term bonds, they pay a greater interest rate than the Treasury rate.

Executives at FRE and FNM receive a huge State subsidy paid by everyone else via inflation. This subsidy is in addition to the subsidy all other banks receive.

When State politicians say "We're guaranteeing the debt of FRE and FNM!", that's a huge perk. Even if the Federal government never writes a check, executives at FRE and FNM may borrow cheaply. The recent bailout made this promise explicit and not merely implied. The explicit bailout was necessary because, despite this perk, FRE and FNM didn't have the cashflow to meet their interest payments. Other lenders started getting worried about a default. FRE and FNM debt started trading at a premium relative to Treasury debt. The bailout closed this spread.

As long as real interest rates are negative, and FRE and FNM keep borrowing more money, then eventually they will profit. Inflation means that the bailout loans are repaid with devalued money. Inflation also means that housing prices will start rising again eventually, making mortgage lending very profitable again.

FRE and FNM received a direct bailout of billions of dollars each. However, their total balance sheet is trillions of dollars. To be fair, *ALL* of the debt on their balance sheet should be included as part of the "national debt".

Executives at FRE and FNM receive huge direct and indirect State subsidies. These executives also spend lots of money lobbying Congress. This obviously leads to corruption. It is immoral to receive a State subsidy, and then spend part of that money lobbying the government for favors.

Insiders in nearly every industry act that way. That's leading to the downfall of the US economy. Via State perks and bribes/lobbying, stealing is more profitable than doing useful work.

A pro-State troll says "FRE and FNM are good! They help people borrow money to buy houses!" The fallacy is that you get a cheaper interest rate, but the price of a house is greater. The profits of FRE and FNM aren't free. Everyone else pays the cost via inflation.

A pro-State troll says "Without FRE and FNM, the housing market would crash further!" This cheap money leads to higher housing prices. Individuals buying a house don't benefit. They get lower mortgage interest rates, but the price of a house is greater. There's no free lunch.

Who benefits from FRE and FNM? The executives at those corporations benefit the most. They earn huge salaries without doing any real work. Homebuilders also benefit, because they borrow money at cheap rates, build houses, and then sell them via FRE/FNM. Anyone with a huge leveraged position in housing benefits from this inflation. The average homeowner doesn't use as much leverage as insiders.

Executives at FRE and FNM receive a huge State perk, and then use those profits to lobby for more favors. Under the usual pressure to "grow their business", they lobbied for looser and looser lending standards. They created a housing bubble to boost their profits. When there was a crash, they got a bailout.

If State parasites wanted real reform, they would shut down FRE and FNM instead of bailing them out. That reform cannot occur, because insiders will lobby against it. FRE and FNM shareholders should get nothing, along with owners of preferred stock. If the corrupt debt is honored, then State parasites should pay that debt off. The government should take possession of the mortgage portfolio and gradually unwind/sell it.

The only real way to reform FRE and FNM is to eliminate them. The only way to reform the financial industry is to eliminate the Federal Reserve credit monopoly and legal tender laws. There are a lot of taxes and regulations that make it illegal/impractical to use sound money. That cannot happen, because too many people profit from the corrupt way things are now. Those insiders will always spend money lobbying to block reform. When you have the State-granted perk of printing money, your lobbying/bribing budget is literally unlimited.

FRE and FNM are a flagrant example of State corruption. Executives receive a huge government-granted perk, and spend some of that money lobbying. Corporate monopolies/oligopolies are desirable, because that maximizes corruption opportunities. As an empire collapses, corruption increases and productive work decreases.

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