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Source link: http://archive.mises.org/8431/fannie-freddie-failure-would-be-world-catastrophe/

Fannie, Freddie Failure Would Be World ‘Catastrophe’

August 25, 2008 by

Bloomberg reports that a former central banker with the Bank of China has made some dire statements about the GSEs:

BEIJING — A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China’s central bank.

“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”

and

“The seriousness of such failures could be beyond the stretch of people’s imagination,” said Yu.

Bloomberg adds ” He didn’t explain why he held that view.”, but it doesn’t seem too much of a stretch to figure this out, when the foreign banks hold several hundred billion dollars of GSE securities.

The unfolding credit crisis is really a box canyon. The large financial institutions are “too big to fail” and “too big to bail”. Letting them unwind would trigger a contagion that would bring down most of the large banks and investment houses, while bailing them out risks a collapse in the dollar and hyperinflation.

As Austrian economist O’Driscoll noted earlier this week in the Wall St. Journal, Washington Is Quietly Repudiating Its Debts.

{ 8 comments }

Current August 26, 2008 at 5:39 am

A few months ago a prominent left-wing commentator in the UK, Will Hutton, recommended that the UK should adopt institutions like Fannie and Freddie.

Imagine the chaos that could have resulted if they had done this, a few years ago say. Or even worse if the EU had done this. F & F are symptoms of centrally planned finance, and Europe is more centrally planned than the US, it’s curious that it hasn’t adopted something similar.

So, in some ways we have been lucky. Things could be much worse.

Not too big to fail. August 26, 2008 at 11:34 am

If GM and Ford aren’t too big to fail then these clowns aren’t either. Both Freddie and Fannie should simply have to declare bankruptcy and hand over all assets for sale to their creditors or simply auction them off.

Stocks are risky. Some fail. The countries that hold these securitites are out of luck.

Besides NOT A SINGLE ONE of the millions of mortages will be forgotten anyway. So the folks forced to use these awful institutions will still be stuck paying their mortgages when the executives skate free.

kurt August 26, 2008 at 12:03 pm

Of the $1.6 trillion debt of these two GSEs, $1.3 trillion is foreign owned. Go figure.

N. Joseph Potts August 26, 2008 at 2:05 pm

Now, what would happen if F & F WERE unwound, and their assets, as whole mortgages (rather than shared interest in all the mortgages), were distributed to the holders of the companies’ paper.
The Chinese government (or central bank) would become the mortgagee of millions of dwellings in the US. Perhaps it could bring to bear collection and eviction techniques that it has honed over the decades on the Chinese people themselves. Through foreclosure, it would become one of the biggest property owners in the US – and China is a country in which land itself may not be privately owned.
The employees of F & F might also be distributed among the holders, but in their case, perhaps it would be better if they WERE divided up and distributed in pieces.

Mike D. August 26, 2008 at 2:17 pm

Fannie and Freddy have already, in more than one sense, failed. The business model of Fannie and Freddy was to use their GSE AAA+ credit status to borrow money at below what private banks such as Bank of America and Wells Fargo have to pay. The spread between AAA+ and AA was essentially a free lunch, that was leveraged to a huge extent. Now the gig is up. This business model is broken. Nobody will lend to Fanny and Freddy at reduced rates. The value of the stock and preferred stock has evaporated. Fannie and Freddy securities guarantee timely payment of principal and interest. The Fed is on the hook to lend Fannie and Freddy money at below market rates to handle shortfalls in the servicing of these existing obligations. However, the huge expansion is over.
I always amuses me when I hear stories about Volker, Greenspan, Bernanke and the Fed fighting inflation. Who and what causes inflation in the first place?

magnus August 26, 2008 at 3:10 pm

I always amuses me when I hear stories about Volker, Greenspan, Bernanke and the Fed fighting inflation. Who and what causes inflation in the first place?

It’s called doublethink.

Peson August 26, 2008 at 4:51 pm

N. Joseph Potts: Good point. But a bit too far: the Chinese couldn’t just use whatever tactics they felt like. They’re still bound by local law and the allowances of the mortgage contracts. You do, however, remind me of something I felt like doing for fun: buy up individual mortgage contracts just to invoke the letter of every right it gives me. So if the contract let me foreclose due to a single day lateness in paying, I’d do it :-)

Another thing: the Chinese seem to be forgetting that they are NOT on a level playing field in things like this. The US government could just seize the houses right back, and obscure the confiscation in procedural technicalities so as to preserve good credit.

Anyone want to write a sitcom about the Chinese government trying to sell homes in suburbia? ;-)

Steven Shaw August 26, 2008 at 10:34 pm

Why are they too big to fail? Perhaps “the end of the current international financial system” is exactly what is needed.

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