http://theautomaticearth.blogspot.com/2010/06/june-16-2010-fannie-and-freddie.html
So, Fannie Mae and Freddie Mac are to be delisted from the NYSE. Stocks on the exchange must either act to boost the share price or delist if they show an average share price below $1 for over 30 days, which has been the case for Fannie Mae. It’s hardly surprising that the companies should be perceived as virtually worthless, considering that they preside over about half ($5.5 trillion) of a mortgage market in terrible trouble. Moving away from even the limited accountability of public listing is also no surprise. Confidence games require reality to be obscured for as long as possible. While the move is being spun, especially in the case of Freddie Mac, as compatible “with a goal of conservatorship and the preservation and conservation of assets”, in reality there is little future value to protect.

Taxpayers have pumped in $145 billion already, as the alternative would have been a property price collapse. That is still clearly on the cards if support were to be withdrawn, hence the unlimited nature of the guarantee that has been offered, meaning unlimited liability for the taxpayer. Support has been greater than for other noted basket-cases such as AIG, and there is no end in sight to the red ink these companies seem capable of generating.

A worst case scenario of $1 trillion in losses has been mentioned, based on a further 20% decline in house prices and a tripling of the default rate. However, I find it inconceivable that such a mild outcome could be viewed as a worst case. Bubbles always show an undershoot to the downside as they implode. Even if one takes an incredibly optimistic view of the scale of the bubble, defining it as only the last few years of excess, that undershoot will cause larger losses than 20% from here. Likewise the default rate is set to skyrocket, never mind merely triple. The losses accruing to Fannie and Freddie are likely to be vastly larger than even the most pessimistic mainstream commentators can imagine.

As longtime readers will know, my forecast for a real estate prices is for a decline of 90% on average, albeit with considerable local variation. For those who think this is not possible, you might want to look at what you can buy a house for right now in Detroit. It is considerably less than the price of a second-hand car, and in a market where the price of second-hand cars is depressed. In places where there is no work for miles around, and no access to mortgages in dying neighbourhoods, the pool of buyers will be limited to those who can afford buy a property in cash and would choose to spend what will be extremely scarce cash on that particular purchase. The price support that will convey will be minimal, to say the least.

As unemployment takes a moonshot in the coming years, purchasing power will be far more limited than most can imagine. The liquidity crunch we are moving into will cause the same kind of economic seizure as we saw in the depression, when a lack of money alone made it exceptionally difficult to connect buyers and sellers, or producers and potential consumers. Money is the lubricant in the engine of the economy in the same way that oil is the lubricant in the engine of your car. Running an engine with too little lubricant will cause it to grind to a halt.

The ‘assistance’ currently being provided in the form of downpayments is only going to make the situation worse in the long run. Bailouts are never for the little guy. Offering inducements to further indebtedness is merely a trap. It will do nothing but increase the pool of future debt slaves. This is not a benefit for the people it is ostensibly aimed at. Instead it is a cynical move intended to keep our game of extend-and-pretend going a little longer. Rising unemployment will cruelly expose the fragility of buying power and the ability to service debt in the relatively near future. Defaults are likely to be shockingly high, and with them losses to Fannie and Freddie.

As John Stuart Mill observed, “Panics do not destroy capital, they merely reveal the extent to which it has already been destroyed by betrayal into hopelessly unproductive works.” The construction of much of suburbia has been a giant exercise in the creation of negative added value. It is this decades-long commitment of resources to living arrangements with fatal structural dependencies that has been destructive of value, and there is a limit to how long we can stave off the day when that will be generally recognized. That is all we are doing in supporting Fannie and Freddie.

Now that it appears the credit markets have turned again, the real economy will inevitably follow. The long rally facilitated a suspension of disbelief that was kind to policy makers while it lasted. The resumption of the downtrend will conversely strip away their credibility, making everything they do fail conspicuously and ignominiously.