Fannie Mae and Freddie Mac takeover will cause oil prices to soar again

[louis c]

how's that?

Fannie Mae and Freddie Mack hold 5 trillion dollars of mortgage debt. Currently, defaults and foreclosures are causing the troubled institutions to collapse. In order to forestall a world wide panic, the US government will takeover the two institutions. That means added debt to the US budget and an inevitable and immediate decline in the US dollar.

Recently, oil prices have plunged nearly $35 a barrel. This has little to do with "supply and demand". As I have stated here on numerous occasions, when you purchase oil in dollars, the increase or decrease in the cost of oil is directly related to the value of the dollar. Because the dollar strengthened relative to other foreign currencies, the price of oil fell.

Now, the multi-trillion dollar burden of the failure of Fannie Mae and Freddie Mac is shifted to the US budget. As a result, it adds debt. There is no difference in this takeover to printing billions of new dollars, thereby depreciating the currency.

The dollar will decline, starting Monday morning, and oil will rise.

Mark these words.

[WheelWalker]

1. Thanks for that insight. Your words are marked !

[indepat]

2. Fannie/Freddie debt is huge, is even more than half as great as the national debt

added since the early 1980s through the Gipper's "voodoo economics." :P

[On the Road]

3. It is Not Debt in the Same Sense at All

It is backed by assets. Even if those assets take a dive, they are predomininantly covered by the collateral. It is a smaller order of magnitude than $5T.

[louis c]

5. Some collateral

If it wasn't "debt at all" why the hub-bub?

the problem is the "collateral" isn't worth half the debt. The 5 trillion dollars isn't all debt. however, the billions in forecloses sure are. And we're talking hundreds of billions of dollars, and many more hundreds of billions to come.

[On the Road]

20. Here are Some Rough Numbers for 2008

Annual Foreclosures: 1,000,000
% Owned by FNMA and FRMC: 50%
FNMA and FRMC Foreclosures: 500,000

How does this translate into negative profits?

Average Mortgage of Foreclosed Properties $200,000 (overall avg = $136,000)
% Loss on Foreclosure: 25% (2Q was 23% up from 18% for 2007)
Total 2008 Loss Due to Foreclosure: $25B

Foreclosures happen every year and are factored into their business model. How much of this is over and above the average?

% of Long-Term Average Foreclosure Loss: 200%
Excess Loss Due to Foreclosures: $12.5B

The $5,000 billion number that is being thrown around is 200 times as great as the actual loss for 2008, and 400 times as great as the excess amount above long-term averages. That is why the numbers are worth correcting.

-------------------------

As to why there is all this hubbub:

FNMA and FRMC, like all financial institutions, are highly leveraged. The market cap of both is about $11B. They are not generating enough cash to meet their own financial obligations. That is why their survival is in doubt without federal assistance. On the federal level, however, it is a manageable amount. It is likely to be a much smaller problem than the S&Ls in the 80s, where the government paid up over $1,000 billion.

-------------------------

None of this is to excuse FNMA and FRMC recklessness, or to justify privatizing profits and socializing risk. It is just not the overwhelming specter that's being presented.

[indepat]

11. Exactly, while the national debt grows exponentially and must be funded by the grace of others,

the United States is growing its monstrous military killing machine complex and letting its infrastructure rot and a significant portion of its people go without access to medical care while others fund our madness and provide some form of universal health care for its people. :P

[TwixVoy]

17. You need to stop listening

to republicans on TV telling you this.

The fact is prices of homes sky rocketed MUCH more than they were actually worth.

It is equal to me walking in to a bank and getting a "secured" loan for 50K using my car that is worth 5K. There is still going to be a huge loss if I default.

[On the Road]

18. I Am Not "Listening" to Anyone

The original poster was making a comparison of apples to oranges. The two kinds of debt are utterly different.

[kurt_cagle]

19. Housing as Assets

Contrary to the infomercials, a house is a lousy asset to have on your balance sheet at the end of the day. It's value generally deteriorates over time, owning a house means paying property taxes (these do not go away simply because the holder of the mortgage is a bank), the value is very much dependent upon the values of neighboring houses (which means that even a good house in an otherwise bad neighborhood will lose value quickly), and in a bad economy selling (or buying) a house can be difficult, which enhances the risk of default ... aka jingle-mail.

Banks liked mortgages not because they wanted to become slumlords, but because the system had become so corrupted that they could sell the mortgage to someone else and earn big fees for doing so. Now that has ended, and like a very perverse game of musical chairs, the large banks now own a significant part of the housing market but are having trouble originating new mortgages so that they can in fact rid themselves of the a growing backlog.

Add into this the fact that when a bank forecloses on a house (which is now the case for nearly 3% of all houses, a figure that is obscenely high), then it becomes a target for vandals and thieves - no one's there to stop them, and a good housing thief can strip a house of everything of value, down to the plumbing. At that point, the house becomes far harder to sell because of the extensive amount of work necessary to get it back up to a livable state.

Certainly, the portfolio of Freddie and Fannie are worth something, but what that something is no one really knows. Given the massive run-up in the last few years, houses are likely overpriced by 40% or more, and figuring a decaying inventory, I wouldn't be surprised if actual losses from the FM twins will end up in the $2-$3 trillion dollar range. Given that the net worth of the US is only around $14 trillion or so, this evaporation of wealth represents a huge (roughly 20%) hit to the total economy ... and this doesn't in fact take into account how much more is to be discovered hiding in the closets.

A final point - a significant number of the loans originated by Freddie and Fannie were essentially of the liar loan variety - you didn't have income verification, didn't have to put together a down-payment, and you were essentially just paying the interest - you didn't even touch the principal. This means that much of the portfolio that they have actually has NO collateral. What's more, since Freddie and Fannie were engaged in the same kind of slice and dice that the other mortgage banks and institutions were engaged in, there's no real way of knowing just where these mortgages now are so that a reasonable estimate can be made of the actual value. This also means that when someone walks away from a house, there's no longer any clear owner for that house, and sorting that out is only going to make the deterioration in the market become worse because it adds time to an already lengthy and complicated process.

[spanone]

4. the most disastrous economic policies ever

[louis c]

6. You ain't just a whisslin' dixie

[lonestarnot]

7. And more jobs will fly out the window raising the unemployment numbers.

[kurt_cagle]

8. Fannie Mae & Freddie Mac

The recent dollar "strength" is artificial, and is tied directly into the FM2 crises. Back in July, the governors of both Freddie and Fannie came to the Feds with the news that they had overstated their working capital by a significant amount, and the recent collapse in the credit markets had basically wiped them out. The Fed very quietly contacted the Central Banks of the EU and Japan, and the respective governments agreed to purchase a rather staggering amount of US Debt, in order to push the dollar back up. They did this primarily because they knew that Freddie and Fannie would need to be recapitalized and essentially nationalized, and that by pushing the dollar exchange rate up, they would have more leverage when it started dropping again.

I'll second the commentary from above. This week is going to be even more brutal on Wall Street than last week was, and the dollar has reached the high point of its recent "strength" (the fundamentals frankly don't support how quickly it's risen). Look for the dollar to start dropping again next week as the impacts of Freddie and Fannie begin to be analyzed, with oil slowing its descent then rising again by the end of September. From a political standpoint, it will be a perfect storm for the GOP - oil's going to start climbing pretty dramatically by the time the election rolls around, even with the apparent "drop in demand" (note: demand for oil HAS dropped, but it hasn't dropped by 30%, which is what the current oil prices indicate - demand's down perhaps 3-4%). What you're seeing in oil prices is a direct artifact of the relative strength of the dollar.

Keep in mind that Bush came into office in 2000 in part due to the country beginning to slide into the recession of 2000-2002, and by 2004 the economy was recovering (at least in theory), the first favourable for a change in political party, the second favourable for the incumbent. However, McCain is now facing a potentially steep recession (in great part due to mismanagement from his own party), rising gas prices, rising heating oil prices (and current forecasts for the Winter of 2009 are for a below normal temperature winter), rising food prices and rising unemployment. Add in a steep decline in the stock market (which is about to occur) and a widening of the trade deficit ironically because the dollar WAS stronger in the second quarter, and you get a recipe for economic disaster for McCain.

One last point here - normally, it would not be unusual for the "neutral" Fed to provide some tailwind for the bank friendly GOP. However, at this stage, most of the larger banks are now fighting for their continued existence, the "tax break" stimulus has proven to be ineffective, and their concern is much more on keeping their investors from bailing than it is getting McCain elected. This means that much of the money that I think GOP operatives were counting on showing up from their financial services allies hasn't. Their convention showed it - my impression throughout was that it was being done on a shoestring budget, possibly because, well, it was.

[louis c]

9. Great Analysis

I've alway contended that the price oil, relative to gold instead of dollars, should be about $40 a barrel. Supply and Demand should not have increased the cost by more than $15 to $20 a barrel over the pasr 8 years. The rest of the increase is as a result of a shrinking dollar.

[SmokingJacket]

13. Thanks for the explanation.

I'm not up on economics, and this makes sense of thing. :hi:

[unblock]

15. demand for oil is highly inelastic, so it doesn't need to drop 30% for prices to drop by 30%

if demand were to increase 30%, prices would easily more than double. there would be actual shortages and people who could get oil would pay just about anything for it.

if demand were to drop 30%, they'd practically be giving oil away.

i agree that currency movements play a role, but demand for the usd is highly *elastic*, so a 10% strengthening of the usd *does* correlate roughly to a 10% decrease in the price of oil.

not so for exogenous demand changes. the price of oil is very volatile due to this.

[ThomWV]

10. My gut feeling is that you're wrong

I suspect that this time next week you'll find the market around 11.5 and oil hovering right around $100.

[kurt_cagle]

14. Re: Gut Check

Markets may very well be at 11.5 and $100 - we've been range-bound for some time between 11.2 and 11.8, and I do not see oil slipping BELOW $100 except possibly in very weak feints. There is also, despite the pressures acting on the market, a desire on the part of Paulson and co. not to disappoint Bush or make the GOP look bad two months before the election. However, the pressure is still there, and when it breaks - now, or on November 5, when it no longer becomes Bush's "problem", it will break, and it will break to the downside for the DOW and the upside for oil prices. I know the fundamentals right now do not support $1.42 on the Euro. I think the question is whether in fact Paulson, Bernanke and the rest have enough sandbags to keep the dam from bursting too soon.

[nichomachus]

12. But the "analysts"

will blame the rise on the hurricane, which will be a factor, but not the complete one. The Sheeple will believe it.

[TwixVoy]

16. I have already tried to warn people

many people at DU don't seem to understand this.

[A HERETIC I AM]

21. Hmmm...I marked these words, but oil was basically flat today and the Dollar continued its rally.

The dollar will decline, starting Monday morning, and oil will rise.

Mark these words.

Doesn't look like the dollar cooperated with your prediction.


Neither did oil.

Hint: Don't give up your day job.