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April 5, 2006 at 9:28 AM #6455
I know that a collapse of Fannie Mae and Freddie Mac is possible. Even Greenspan has testified to Congress about the systemic risk possible, and he wrote: “On the other hand, if we fail to strengthen GSE regulation, we increase the possibility of insolvency and crisis.”
I believe we’re heading into a recession as housing cools. The first economist to echo my views, is John Talbott, author of Sell Now. He makes a case that the housing decline will have nationwide, and international consequences. As wrote before, real estate related jobs will diminish, and consumer spending will drop. Perhaps some banks will be affected. Mr. Talbott states that for sure, banks and GSEs will be affected, and there could even be a run on the banks.
An excerpt,p. 144:
“Fannie Mae and Freddie Mac are leveraged over 100 to 1 in aggregate (that is, their real assets only cover 1 percent of their loans), so if only 2 percent of their portfolio experienced 50 percent credit losses, they would be technically out of business. The taxpayers would have to pick up the bill under their implied guarantees, a tab that could easily run as much as 20 percent of their total assets, or approximately $500 billion.
And because 40 percent of the total assets of commercial banks are residential mortgages and real estate holdings, a decline of only 12 percent in the price of their entire portfolios of mortgages and owned real estate assets would wipe out their total bank equity, which is typically about 5 percent of their toal assets.
Worse, banks don’t actually have to lose money before the real threat is realized. The real threat is the loss of confidence of depositors in the banking system. If depositors believe there is a chance that their depostis will be impaired, they can withdraw them. Of course, because banks leverage deposits, they have only about 5 percent in cash on hand at any time to repay all the depositors. The rest is in illiquid longer-term assets like mortgages and business loans….The federal government has adequate means to prevent a bank run on any one instituion, but it does not have the liquidity to save all the banks. Because this would be the first national housing crash, and because almost all banks hold a significant amount of their assets in mortgages, the federal government would have great difficulty guaranteeing all the depositors’ funds….
A $5 trillion decline in the value of residential real estate in America, or a worlwide housing price decline of $15 trillion, is almost impossible to handle and maintain the stability of the banking system…The entire GDP of the United States is only $11 trillion…Free market economies require the confidence of consumers, workers, producers, lenders, and savers that contracts will be honored and banking and monetary systems will be stable…”
This is the most pessimistic part of the book. Talbott is not a doomsday sayer. So when I found this on page 144, I sat up and took notice. Perhaps we all need to think clearly about why Greenspan warned Congress about a systemic risk to the financial system due to Fannie and Freddie, why Warren Buffet divested his holdings several years ago, and what really can happen to not only our economy, but our entire banking sytem, if housing collapses by 50% in the the bubblicious cities. The impact will be much worse than just a few people facing foreclosure, some layoffs, and Nordstrom having a bad year.
How much worse than the S&L crisis will this be?
Any comments would be appreciated. And now, as I’m chastised by sdrealtor, I better stop trolling the internet and go out and mingle with other people.April 5, 2006 at 12:05 PM #239984plexownerParticipant
The history of fiat currencies is that they last about 50 to 70 years before they are rejected by the people.
Usually, the people revert to gold and silver as currency because trust has been lost in the fiat currency (which was always worthless anyway). Governments reluctantly follow the people into silver and gold backed currencies until they can pull the wool back over the people’s eyes and introduce another fiat currency.
(Please don’t debate me on these points – if you really care, go do some research – be a student of history as your founding fathers were and you will understand why they wrote in the Constitution that only silver and gold will be legal money in the United States.)
The US dollar is a fiat currency and I believe it is currently at the end of its 50-70 year lifespan. The fact that the Federal Reserve has chosen to hide M-3 and repurchase agreement numbers (as of April, 2006)confirms to me that they are doing everything they can to prop up a failing economic system (which includes the fiat US dollar and the banking system that operates in the US dollar).
It is my opinion that we are headed into the next great depression. This one will be more dramatic than the one in the 1930s and it will encompass the entire globe. Declining real estate values and failing banks will be just a few of the steps on the downward staircase. It is also looking like disease and famine will occur on a global scale in coming years.
The current generations of Americans are not going to handle economic depression well at all! Very few people have seen hard times and we’re about to have them in spades!
Declining housing values will be the least of our worries in the coming years.
Believe it or not, I am not a pessimist even though I hold these pessimistic beliefs. I have reached these opinions during 5 years of research on the US and world economy. I have focussed in particular on the history of money and fiat currencies because I believe fiat currencies are the biggest scam ever pulled off on the people of the world. I believe that anyone who spends the time and energy to do the research I have done will arrive at the same or similar concusions.
I also acknowledge that most people will remain asleep in front of American Idol and other reality-TV tripe. These people will be blind-sided by the economic collapse and will, unfortunately, look to politicians to rescue them (which just starts the fiat currency, welfare-state cycle over again).April 5, 2006 at 1:56 PM #23999
What you write is definitely possible. Assuming all will come to pass as you say, how would one be prepared to survive it, financially and physically?April 5, 2006 at 7:39 PM #24003
It is quite a scary thought and I have recently started to subscribe to it as well. I recently read someone compared US to the Roman Empire … the tail end of it. And I guess it is feasible as the US has prospered through its 200+ year history. Perhaps it has come to the end of its natural life and is due a complete overhaul ?
There are a few things I personally have started doing or have at least considered. Feel free to give me your comment.
1) Gain exposure in commodities, especially gold if the fiat ccy does collapse. Check out IGE, DBC, GLD, IAU and the soon to be launched Silver and Oil ETFs, also http://www.goldmoney.com
2) Invest in hedge funds that could short the market on its way down.
3) Hold on to my house (I know this sounds strange) which I know I can pay off with relative ease so as to ensure I’ve got a roof over my head in a worst case scenario.
4) Diversify into foreign currencies … like canadian dollars which will likely stay strong, or EUR which could become another oil currency.
5) Get a job in China / India which is relatively “young” as a world power.
6) Short the housing marketApril 6, 2006 at 3:39 AM #24005
I asked my brother, a genius on all things legal, techical, and financial, to comment on this post. In 3 e-mails, I got this:
One of the really big question marks is the largely unregulated derivatives market, which has massive nominal amounts outstanding. From all accounts Fannie Mae is a huge player in the $123 TRILLION notional amount interest rate swap market, and if it collapses and defaults on its obligations, it could cause massive cross-defaults – which of course the gov’t would have to bail out to avoid the collapse of the banking system (and yes, that is actually possible that b/c of the failure of one large derivatives player, say JP Morgan, the entire banking system would become insolvent). See e.g. Gold-Eagle.com:
“Indeed J.P. Morgan Chase dwarfs everyone in this business. The business is derivatives. In the USA J. P. Morgan Chase is over 50% of the derivatives market. According to figures from the Office of the Comptroller of the Currency (OCC) as at December 31, 2001 JPM had notional amounts of derivative contracts outstanding of US$ 23,520 billion or US$ 23.5 trillion. That was out of total derivatives of reporting banks of US$ 45.4 trillion. The aforementioned Royal Bank of Canada had at the end of their second quarter a notional amount outstanding of approximately US$ 1.2 trillion.”
By comparison the US GDP totals roughly US$ 10 trillion and total outstanding debt of all sectors totals just over US$ 19 trillion.
Derivatives are contracts based on the value of some other asset or financial measure. A typical interest swap would say, “I pay you 5% interest on $10 million” (where $10 million would be the “notional amount”), “and you pay me the prime rate on $10 million, payable in net amounts quarterly over the next 5 years”. In this example, if the prime rate is below 5%, I make money; if it is over 5%, you make money.
Of course they get much more complex – you have currency swaps, caps, collars, commodity (based on price of gold vs. price of oil or currency value). They can be used to hedge risk (e.g., Fannie Mae may need to finance itself at a variable rate of interest, but may make long-term loans at a fixed rate, so it may enter into a swap agreement to convert the variable rate it has to pay to the fixed rate it receives) or for speculation.
There are established derivatives dealers. As you saw, JP Morgan is the biggest, but almost all commercial banks enter into them. They are also regulated to some extent (banks need offsetting transactions to keep things in balance, but of course if one side fails, like Fannie Mae, and the bank is not able to cover its position, the balance can get quickly lost and the bank goes insolvent since it may owe billions on the hedge and not get any money under the contract – imagine e.g. a Fannie Mae 10% swap on $5 trillion notional amount, that is $500 billion per year or $40 billion per month).
I am moving my money into two types of funds: Euro / Pacific companies (with investments held in foreign currencies, rather than dollars) and precious metals and other natural resources funds (e.g., uranium, timber, copper). I am keeping 35% in a money market fund as a hedge, everything else I am moving into real assets (the natural resources) or into other currencies (you just know the Yuan will become more valuable a/g the dollar).April 6, 2006 at 5:08 AM #24007
Unfortunatly there’s no easy way to convert USD into Yuan in a major way yet … unless you do what I do … that is move to china and make a living in yuan !April 6, 2006 at 8:24 AM #24008privatebankerParticipant
Here’s an interesting twist to what you are saying here:April 6, 2006 at 8:50 AM #24010April 6, 2006 at 11:21 AM #24016
Thanks. I think a bet on the revaluation of yuan would require patience. Interest rate differential is probably around 2% plus spread the bank charges. And from what we gather at this end, the chinese gov will resist as much as they can … so as not to follow the footstep of the japananese which allowed the yen to appreciate during the 80s that finally led to a huge bubble.April 6, 2006 at 11:38 AM #24018
Can you elaborate, I didn’t understand, since I don’t know what happened with the yen in the 80s.
Also am reading that some Chinese senior officials would like to diversify out of the USD. Are Chinese concerned about the fallout to the Chinese economy as we enter our recession, as the American consumer cuts back drastically on spending in the next few years. Remember, the only way we could afford to buy all those Chinese goods if from home equity withdrawals. That game is over, and the last trickles of refinancings are now going on. March sales among US retailers was disappointing. What do you feel/read over in China about all this?April 6, 2006 at 8:12 PM #24038Jim BrubakerParticipant
I can identify with 4plexowner. I share his views. I think that one thing needs to be pointed out, its not the banks that are going to “take it in the shorts,” its going to be the Mutual Funds that everyone is into.
They are not FDIC insured.
Don’t accuse me of yelling fire in a movie theater,but the banks are not that stupid, its your Mutual Funds that are going to eat you alive. After all, 31,000 mutual funds linking to the S&P500 index with a index fund is a sheer lunacy. Using that option leaves them free to invest in real estate loans. If one goes down, they all go down.April 6, 2006 at 10:12 PM #24049
If you’re my age (I’m moving towards the big 4 Os) or even more senior, you may remember Japan was king in the 80s when they were supposed to soon take over the world ? Well it turned out to be one big giant stock and property bubble that once bursted it took them more than a decade to recover; and judging by the stock index it’s still a loooong way to recovery. Some scholars said the bubble was partly caused by the appreciation of the yen. And there were press stories about chinese scholars warning about not following their footsteps.
Worries over a slow down in the US economy don’t seem to be an every day topic over here. If the public is worried about that I certainly haven’t felt it or at least it’s not headline material yet.April 7, 2006 at 10:06 PM #24093
The Washington Post article today summarized yesterday’s meeting, at which John Reich, director of the Office of Thrift Supervision, and John Dugan, Comptroller of the Currency, discuss the reasons for the new mortgage guidance. Is the American public listening?
“At yesterday’s meeting, Reich also warned that some lending institutions are making too many commercial real estate loans, a policy he noted has in the past “contributed to significant bank failures and instability in the banking system.”
John Dugan, comptroller of the currency, who also spoke at the meeting, echoed Reich’s concerns about the volume of commercial real estate lending. He also likened it to the lending pattern that preceded the savings and loan bailout of the early 1990s.”
Is anyone else thinking that the wave of warnings from government officials in recent days is a hint to the markets and the public about the inevitable mess that lies ahead? Does anyone remember government officials giving these warnings? I guess if the banks go down, no one can say they weren’t warned.July 23, 2008 at 9:55 PM #245613bsrsharmaParticipant
You Know The Banking System Is Unsound When….
Very scary but rational and convincing analysis.July 23, 2008 at 9:55 PM #245762bsrsharmaParticipant
You Know The Banking System Is Unsound When….
Very scary but rational and convincing analysis.
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