Yesterday I heard a piece of nonsense on NPR.
Commenting on the financial peril of Fannie Mae and Freddie Mac, the NPR talking head said ‘..officials said that bad mortgages will be covered by reserve funds from the Federal Reserve…’
The only difficulty is that the Federal Reserve is not a reserve. It has no funds. The Federal Reserve is a money-creating factory.
The Fed’s liabilities are Federal Reserve Notes. What’s a note? A promise to pay: a certificate of debt. Look on any bill and you’ll see the inscription, “This Note is Legal Tender for all debts, public and private.”
What are the assets of the Fed? U.S. Treasury securities. A Treasury security is a piece of paper from the Treasury that says that it will pay the amount denominated on the security.
How does the Fed pay for these securities? By simply crediting the account of the United States. It can do this because a U.S. Treasury is considered an asset: it is essentially a future promise to pay by the American people, through taxes.
So whenever the government goes into debt, the Fed makes money: the interest payments that the U.S. pays on those Treasury securities. Nice trick, eh? Don’t you wish you could print money every time your debts exceeded your liabilities? And then get people to pay you interest on that self–created money? The interest on the national debt is about $373 billion dollars, and rising every year. This is the money the government must pay the Fed for money we’ve already spent.
But of course, when the Fed creates more money to “fund” the debt of the United States, it creates inflation. Inflation is a depreciating currency brought about by too much currency chasing too few goods and services. Notice I said currency, not money. Federal reserve Notes are not real money, because they have no value. They are backed by nothing except the ability of the government to levy taxes.
So where are the funds coming from that will guarantee the debt created from the sub–prime mortgage crisis? Why, either from taxes, or from the printing and creating of more money. Which one do you bet on?
Freddie Mac and Fannie Mae will be “funded.” That means, more debt will be created, and that means, of course, more inflation and a further depreciation of our already battered currency. Do you think prices are high now? Just wait until the government gets finished “handling” the sub–prime crisis!
People, never believe newscaster talking heads or politicians, when they talk about funding government agencies. The only honest way for government to get money is through the collection of taxes. But politicians don’t like to raise taxes. So instead, the government borrows more and more money from the Fed, which creates the tax called inflation. Inflation erodes your purchasing power, just as surely as if you had to write the government a tax check.
Freedie Mac and Fannie Mae are known as GSE’s, or government Sponsored Enterprise, unlike the FHA (Federal Housing Administration), which is an actually federal agency, and which is self–supporting. The FHA has strict guidelines for mortgage issuance and the program is paid for by homeowner insurance premiums.
There are basically 3 mortgage finance GSE’s, Freddie Mac, Fannie Mae, and the 12 Hone Loan Banks. The important thing to remember here is that Freddie Mac and Fannie Mae are privately owned but publicly chartered; this means that the Federal government guarantees the profits of private investors. And when this trust is abused, as it has been during the past decade,we pay the price. Although GSE securities carry no explicit governmental guarantees, in practice all funds guaranteed by GSE’s are covered, because politicians do not want to be responsible for people losing their homes.
The problem is that Freddie Mac and Fannie Mae have been stuck with bad mortgages. In their greed for profits, bankers abused their mortgage underwriting privileges and left the government to foot the bill.
Freddie Mac is a stockholder-owned corporation established by Congress in 1970 to provide liquidity, stability and affordability to the nation's residential mortgage markets. That’s a fancy way of saying that it will bail out mortgage bankers if they get into trouble with bad loans. Fannie Mae was created by Congress in 1938 and rechartered in 1968 to expand the flow of mortgage funds in all communities.
Unfortunately, greed and abuse by mortgage bankers, and a lack of oversight, has caused the dire financial difficulties at these GSE’s. Basically, what Fannie Mae and Freddie Mac do is bail out banks that make bad loans.
Now bad debt is a problem in any legitimate business, so there’s no problem there. However, in recent years, banks have gotten greedy, and sent their mortgage brokers around the country, writing mortgages that they knew were bad. “What the heck,” they said, “we can collect the interest until the borrowers can no longer make the payments. Then the government will foot the bill.” Well guess what folks, the “government” is me and you.
The projected budget deficit for the 2008 fiscal year is projected to be $410 billion. The national debt is over $9 trillion and growing every year. Our current account deficit (exports – imports) average over half a trillion every year. But the Republican and Democratic parties blithely keep borrowing and spending, year after year. The mainstream press thinks this is just ducky. The citizenry has no clue that our government is rapidly going bankrupt, if it has not already done so. I wrote about this in an earlier blog post called “Nero Fiddles While Rome Burns.”
What happens if you max out your credit cards and can’t make the minimum payments? You declare bankruptcy. And that is exactly what will happen with the Federal government. Either the dollar will be “refloated” –– which means it will be lowered in value relative to other currencies (something which is long overdue) –– or the government will announce one day that the 60,000 in your savings account is now worth 6,000. Or $600. Don’t laugh; that’s what happened in the old Soviet Union between 1991 and 1994, when the ruble, which had previously been valued at over a dollar, fell to its low of about one-fiftieth of one cent (that is, one dollar fetched 5,130 rubles). * In 1991, the Central Bank of Russia announced its first great ruble reform: it froze all savings accounts and declared all 50- and 100-ruble notes worthless. This led a Russian electrician standing outside the bank that had confiscated his life savings to famously proclaim, "First there was nothing to buy, and now there is no money to buy it with. In the Soviet Union, this is economic reform." **
Think it can’t happen here? Well, it can, and it looks like it will, unless we wake up and smell the coffee. In 2008, the positions of the U.S. and Russia are reversed. The U.S. is the world’s largest debtor nation, and Russia now has a currency reserve of $413 billion, the largest per capita foreign currency reserve of any major economy, including China’s. ***
You see, we don’t live in a fantasy–land, even though the Republican and Democratic parties think we do. Reps and Dems see nothing wrong with borrowing and spending more every year, creating inevitable economic disaster! Yet the electorate continue to vote them in. It just astounds me. If you ask 100 people about the government’s deficit spending, 50 will just shrug and say, “so what?” The other 49 will say, “oh, does the government run a deficit?” Maybe 1 out 100 citizens really understand what’s going on. I think that’s an optimistic estimate, actually.
An ignorant citizenry cannot remain strong and free. When the government plays fast and loose with your money, you should be outraged. But apparently, it is business as usual in the good ol’ USA. People will, apparently, continue to vote Democratic or Republican, rewarding the very people who are destroying our economy and our currency.
All I can say is, WAKE UP AMERICA!
Before it’s too late.
* Michael Lewis, “The Capitalist; Ruble Roulette” The New York Times Magazine, August 13, 1995.
*** Andrew E. Kramer, “The Almighty Ruble,” The New York Times World Business, August 8, 2007.