Recently, it was reported that the government was upping its bailout to GMAC by another few billion. That latest bit of largess with taxpayer funds struck me as emblematic of a continued willingness by officialdom to do “whatever it takes” to prop up favored industries, damn the fiscal or monetary consequences.
Yet, tossing bad money after bad to keep GMAC afloat pales in comparison to the stunt the U.S. Treasury pulled on Christmas Eve. A stunt I have meant to comment on, but am only now getting to, encouraged in part by an excellent article on the topic by John Hussman of the Hussman funds, titled Timothy Geithner Meets Vladimir Lenin.
The event I’m referring to is Treasury Secretary Geithner’s Christmas Eve announcement that the Treasury was removing its caps on the losses it would cover for Fannie Mae and Freddie Mac, now de facto mortgage arms of the U.S. government. That decision, which appears to exceed the Treasury’s constitutional authority, paves the way for the government to bail out the Fed on its $1.25 trillion in mortgage securities, purchased as part of the extraordinary measures the government has taken in the current crisis.
Simply stated, Fannie and Freddie now guarantee essentially all of the mortgage paper held by the Fed. As that paper goes bad or is sold off, it will be left to the Treasury – which is to say, to us, dear U.S. taxpayer – to cover any losses.
Hussman’s commentary does an excellent job of summing up the net result of this latest desperate action. And I quote:
What has happened over the past two years is that the Federal Reserve has purchased about $1.25 trillion dollars in mortgage-backed securities issued by Fannie Mae and Freddie Mac – securities that the Treasury has now made an unlegislated (or at minimum, unintentionally legislated), bureaucratic decision to fully back. Now, as the underlying mortgages fail to produce adequate cash flows, but Fannie Mae and Freddie Mac are called on to pay them off anyway, the Treasury has committed to “allow the cap on Treasury’s funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth.”
In a sharp break from the past, the issuance of these Treasury securities will not be accompanied by any revenue to the government for Congressionally approved programs. The Treasuries will be issued, the money will be handed over to Fannie Mae and Freddie Mac, and those funds will go largely to the Federal Reserve and other holders of existing mortgage debt simply to replace the bad, but bailed-out agency securities with cash as they mature. The public gets nothing for something – the issuance of the Treasuries is in itself their expenditure.
None of this changes if the Fed is somehow successful in “unwinding” its $1.25 trillion in agency holdings by selling them out to the public and re-absorbing the similar amount of monetary base that now sits largely in the form of bank reserves. Such a transaction does nothing to change the overall quantity of government backed liabilities that must be held by the public in some form. Unwinding the Fed’s position simply means that the global economy will be forced to absorb not only the mortgage securities themselves, but also the newly issued Treasuries that will be required to make those mortgage securities whole.
Every dollar of bad mortgage debt that should have been written off is now enshrined as two dollars of government-backed debt. One dollar as the original debt, which will now be made whole, and one dollar of new Treasury securities, which must be issued to make that original debt whole. Accordingly, the holders of both securities will have claims against our national assets and future wealth. A similar two-for-one obligation holds true for bailed-out bank losses.
Freddie and Fannie have now become an open-ended source of Fed funding – as their balance sheet is now explicitly that of the U.S. Treasury. This newest scam allows the Fed free to print up all the money it needs to buy mortgages, and thus keep mortgage rates low, confident that no matter how smelly the paper is that it buys, you and your progeny will stand behind the loss. Meanwhile the nation’s monetary base continues to balloon.
If there is a bright spot to this, other than that it confirms us in our inflation expectations, it is that the desperation evident in these actions portends that the Fed and the Treasury are running out of rope. While I realize it will result in widespread hardship and am sorry for that, I can only wish that this whole fraud unravels sooner rather than later – because the longer reckoning day is postponed, the worse it will be when it arrives.