The Situation with the GSEs

The Federal Reserve and the government of the United States have a very serious and delicate situation to handle and manage amidst its own primary issue of a weak and slowing economy plus a government that has no money as it is running deficits in both its domestic and external current accounts.


Freddie Mae and Freddie Mac gave birth during the Great Depression of 1938 to help get the U.S. economy and country back on its feet. The government sponsored enterprises – GSEs bought over all the mortgage portfolios from the banks, thereby injecting liquidity back into the banking and financial systems.


Looks like now, the reverse is happening; the government and the Federal Reserve needs to come rescue the GSEs. When a government is running a negative current account, how can it help, accept to ‘print’ more monies……………further weakening the U.S. Dollar or sell more securities and pay higher interest rates or worse still just book a ‘credit’ entry in its ledger. The government does not have a choice; its guarantee is being called upon to perform and it has to be very careful the option it chooses to raise capital.


However, some lawmakers and fellow congressmen in the Congress are taking up issue as to the manner in which the GSEs have fallen ill. The objective of the GSE is to underwrite mortgage loans. In fact, it has underwritten US$5 Trillion of the total US$12 Trillion mortgage market. However, when its books grew to a very large size, it decided to securitize the loans to create more ‘room’ to take on more mortgage loans. In the process, it also decided to invest and buy some of these securitized mortgage obligations, otherwise known as CMOs or CDOs in order to enhance its dividend yields to investors who have purchased its securities.


The end result is leverage upon more leverage and when the underlying values of the mortgage values started to shrink, all of a sudden the entire portfolio went into negative equity. Then, the defaults began, and then the write downs followed.


The point I am making is that the ‘core lender’ of the mortgage market in the U.S. is ill and needs government intervention. The government and the Federal Reserve had already intervened in the banking and financial industry; look at how it had lent monies to JP Morgan to buyover Bear Stearns………..and at less than 10% of market price………what a joke! Good for JP Morgan………bad deal for Bear Stearns and also for the Federal Reserve.


In aggregate, what are we saying? The health of the U.S. economy is balancing on the high wire! The U.S. economy is predominantly a domestic market driven by both consumer spending and real estate.


Consumer spending has fallen dramatically, consumer confidence has at very depressed levels and for very good reasons; job prospects are bad, job promotions are bad, securing new jobs are bad…………and lots and lots of people are getting laid off!


The real estate market has been falling in value for the past 18 months and we believe the worse is still not over. The Federal Reserve and the Government has a very difficult task trying to balance growth, inflation, a depressed real estate market and a consumer with the lack of spending power.


This implies that the US Dollar is not about to go anywhere but southwards for a while. Interest rates are also going to be kept on hold for a while as the government and the Federal Reserve needs to fund huge amounts of monies to bail out the GSE and it hopefully desires to do that at low interest rates……………the saga continues…………