Fannie and Freddie running the printing press

In his WrapUp, Tony Allison brings two very important pieces of news to my knowledge:

One of the ongoing risks is a lack of transparency and understanding of the derivative crisis. One expert that has spoken out extensively is Satyajit Das. He is beginning to sound like a modern-day Paul Revere. The following quote appeared in a column by John Markman last September on TheStreet.com.

“One of the world’s leading experts on credit derivatives (financial instruments that transfer credit risk from one party to another), Das is the author of a 4,200 page reference work on the subject, among a half-dozen other tomes. As a developer and marketer of the exotic instruments himself over the past 30 years, he seemed like the ideal industry insider to help us get to the bottom of the recent debt crunch—and I expected him to defend and explain the practice.

I started by asking the Calcutta-born Australian whether the credit crisis was in what Americans would call the “third inning”. This was pretty amusing, it seemed, judging from the laughter. So I tried again. “Second inning?” More laughter. “First?” Still too optimistic.

Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we’re actually still in the middle of the national anthem before a game destined to go into extra innings. And it won’t end well for the global economy.”

One would hope this derivative mess is now in the middle innings, but that may prove a tad optimistic. The problem is that bankers, economists and particularly politicians do not understand how derivatives work, and what real dangers they might present. When a true derivatives expert says we should be very afraid, perhaps it would be wise to pay attention.

Das made a return visit in Markman’s May 7th column. He doesn’t see the light at tunnel’s end just yet. “Given that the bank presidents have been consistently wrong about everything they’ve said about their losses until now, why on earth would anyone believe them now?” Das asked. He also mentioned the $1 trillion to $3 trillion that is in the process of moving onto the bank’s balance sheets from related entities where they were hidden. As to where we are in the credit crisis, Das dryly paraphrased Winston Churchill.

“This is not the end, or even the beginning of the end, though it may be the end of the beginning.”

While amusingly ironic, it does not give great comfort to a reeling global financial system. This may be one more reason to say cautious and buckled up.


The Economist last week published “End of Illusions”, an article about “America’s deeply flawed system of housing finance.” The paragraphs below are excerpts from a more extensive article.

“After a headlong plunge in the two firms’ share prices, Hank Paulson, the treasury secretary, felt obliged to make an emergency announcement on July 13th. He will seek Congress’s approval for extending the Treasury’s credit lines to the pair and even buying their shares if necessary. Separately, the Federal Reserve said Fannie and Freddie could get financing at its discount window, a privilege previously available only to banks.

The absurdity of this situation was highlighted by the way the discount window works. The Fed does not just accept any old assets as collateral; it wants assets that are “safe”. As well as Treasury bonds, it is willing to accept paper issued by “government-sponsored enterprises” (GSEs). But the two most prominent GSEs are Fannie Mae and Freddie Mac. In theory, therefore, the two companies could issue their own debt and exchange it for loans from the government—the equivalent of having access to the printing press.”

“With the credit crunch, Fannie and Freddie have become more important than ever, financing some 80% of mortgages in January. So they will need to keep lending. Nor is there scope to offload their portfolios of mortgage-backed securities, given that there are scarcely any buyers of such debt. And if the Fed has to worry about safeguarding Fannie and Freddie, can it afford to raise interest rates to combat inflation? American monetary policy may be constrained.”

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