The Fed - A True Haven for Capitalism?

 |  Includes: FMCC, FNMA
by: Dan Schmeidler

Fannie (FNM) and Freddie (FRE) have just left the building. Their offices shut down. Raided by the actions of Uncle Sam. Also at the scene nearby, Bill Gross. But now, Uncle Sam is stepping in to take control of the balance sheets with plans to greatly reduce their function in the mortgage business after 2010. Sure this makes sense. For once, the taxpayer should accept the confiscation of these assets: They are shrinking, deteriorating, or hurting the economy. The perception is that this action will heal the markets as healthier (and more competent) entities will eventually enter the mortgage securitization business and once again establish order.

The government might have taken its clues from Bill Gross, the important recipient/creditor/pivot-man in the much ado Fannie and Freddie paper world. Bill Gross, incidentally, recommended the confiscation of these assets. Are we surprised? Of course, not. A man in his capacities would be the last person to recommend the complete shut down of an ill-fated mortgage securitization business. Maybe he understood that the Feds had to make choices. And, he knew their weakness: Facing those old guarantees that got them in this mess in the first place.

After all, there are obligations, and through confiscation, the Feds are demonstrating to nervous markets as to how far they are willing to go. They tell us that what the Feds guarantee, the Feds own. Pretty good for creditors, no? The spreads seem to reflect so. But how does this reflect on the rest of the markets? Like the financial markets, or the credit worthiness of paper that will be issued tomorrow, next week, a year from now.

Well for once, this "shedding of balance sheets" (see Bill Gross about that) will now continue under the helm of Uncle Sam. So here we are shedding the old Fannie/Freddie balance sheet and infusing our own capital when necessary. And of course, being the honest government, there will be full display (to the taxpayers) of all accounts, including assets and capital. The liabilities? Those will stay on the books, as is. It appears that an alternative solution of engaging creditors about the creditworthiness of debt was the less desirable choice of the day. After all, it should be relatively easy to deal with capital when you are in charge of the printing press.

So, with these aforementioned vast balance sheets slowly being re-circulated into our economy, when will we see the final curtain drawn on the Fannie and Freddie era? Well, that depends on how quickly we steer away from the habit of nurturing and recycling such ailing balance sheets.  According to Bill Gross we will continue to create new and healthier balance sheets as a result of this type of ongoing liquidation. For now, it appears that these newly generated balance sheets will be at the hands of the entities able to compete effectively in the old Fannie and Freddie arena. Let's keep our fingers crossed that their future debt offerings and subsequent securitizations (with or without government guarantees) won't throw our economy into an increasingly deeper tailspin.