Fannie, Freddie & The nightmare on Wall Street

Fannie, Freddie & The nightmare on Wall Street

KNOW Fannie Mae and Freddie Mac?

18 August 2008

KNOW Fannie Mae and Freddie Mac?

You should, because these US mortgage giants have created a US$5.3 trillion ($7.5 trillion - gasp!) financial black hole that the whole world has been dragged into.

What happened here? And who should we blame?

Hold your horses, dudes. Bring me the popcorn and soda first. And I will tell you a story about a feel-good, black-and-white Hollywood movie made back in 1946, back when life was simpler.

Movie Hero

In It's A Wonderful Life, all-American hero George Bailey (played by James Stewart) saves his building and loan association from a run by using the money from his own wedding dowry - all US$2,000 of it - to supply cash to his panicked depositors.

Young GB tells the town's people that things aren't as gloomy as they appear. He tells depositors that 'we're all in this together' - that their money is tied up (stuck, lah) in their neighbours' houses... as an investment.

Though jittery, the townsfolk trust in young GB's honesty and agree to withdraw only what they need to last the week.

At the end of the day, when the financial house closes its doors, it is spared from going bust - all because of a balance of US$2.

Young GB is your model investor - he saves, he reinvests dividends.

He takes the long view while others around him mock him and snap up short-term gains. He sticks to his core values, though at times he feels shortchanged.

Fast forward some 60 years later and the sub-prime crisis, initially unnoticed, in the US in 2006, morphed into a full-blown, headline-splashing global panic by July last year.

Rising interest rates, which increased the monthly payments on newly popular adjustable rate mortgages, left many American homeowners unable to service their loans.

However, something uniquely American was on their side.

The home loans were on a 'no recourse' basis - that is, a borrower could easily 'walk away' and nothing else would happen to him, other than the lender seizing his house and reporting the default to a credit agency.

And, guess what?

Many Americans did just that - especially those with the so-called sub-prime loans. They walked away without sparing any thought for their lenders.

Meanwhile, property values, which suffered from the bursting of the US housing bubble, left the by-now-desperate American banks without a ready means to recoup their losses.

This, in turn, led to declines in stock markets worldwide, several hedge funds becoming worthless and, not surprisingly, it also led to the bankruptcy of several mortgage lenders.

Barely a year later, just last month, I witnessed 'live' on CNN another GB making a shock announcement.

Not our young George Bailey, but our not-so-young US President George Bush.

Taxpayer's Money

Old GB talks about the health of Fannie Mae and Freddie Mac and, get this right, the huge repercussions which would occur in the banking and mortgage industry if either one fails.

His stop-gap solution: Truckloads of US taxpayer's money for both Fannie and Freddie. Much more than the US$2,000 that young GB put up.

Uncle Sam's share of the bill is now estimated at US$300 billion, based on the Housing and Economic Recovery Act of 2008 that old GB signed into law on 30Jul.

How deep is this US cesspool?

At this point, the truth be told, no one really knows for sure.

But the direct result of this financial uncertainty has been a traumatic collapse in trust.

This is worrisome since the sole foundation of today's banking is trust.

So what's next, doc?

Some analysts say a US government bailout for Fannie and Freddie is unlikely and that, in any event, it shouldn't be hurried.

They say there's still time for Fannie and Freddie to raise more money from the capital markets, but with some kind of government backing. Others say the time to act is now, before things get worse.

I say, let's replay It's A Wonderful Life - to understand the real truth, to learn the real lessons. Let's also remember young GB. Let's restore trust first. The rest will follow.


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Our new columnist

HE calls himself a Boston Brahmin.

And he aims to figure out the big numbers in the news for busy readers.

Harvard-trained economist Zhen Ming is a branding consultant who will bring to The New Paper more than 25 years of cross-border business, banking and broadcasting experience.

He co-founded the TV show Money Mind on Channel NewsAsia.

While with a local Big Three bank, he dealt with offshore syndicated loans in the region.

He is a member of the American Management Association's Pan Asian Council, a life member of the Economic Society of Singapore and a former Honorary Secretary of the Harvard Club of Singapore.

He also co-founded Business Angel Network (South East Asia) Ltd, a not-for-profit organisation.