Markets thought the world was saved; judging by the size of the rebounds in the past day after the saving of America’s imploding mortgage giants, Fannie Mae and Freddie Mac.
London rose, despite being down for seven hours, the US soared, then eased pointing to a more sober day here today. After Wall Street jumped 287 points, our market went all shy and futures trading suggested a flat opening compared to yesterday’s 3% leap.
Investors here understand the nature of relief rallies by now.
As dramatic as the increases were, led by Australia and Asia and finished off in the US, there’s a long, long way to go for the two mortgage groups and for the financial systems not only of the US, but Europe and the UK.
Like or not the moves to bail out Fannie and Freddie once again remind us that the financial systems of the world’s two major economic powers, the US and Europe, are effectively on life support, with most of the money coming from the battered US Government and Federal Reserve.
Without the series of moves by the Fed and US Governments this year, the world economy would be in crisis.
The life support system was completed when the US government staged an unprecedented and wide ranging bailout of the country’s tottering financial system with a $US200 billion plus deal to take control of the tottering mortgage giants, Fannie Mae and Freddie Mac.
As well 12 Federal Home Loan Banks will be given a liquidity lifeline to prevent their failure.
US banks and other financial groups who hold most of the $US73 billion of preferred shares issued by Fannie and Freddie will not be allowed to fail if they suffer losses as the preferreds lose value and in turn destroy their capital reserves, with the Fed and three leading US bank regulators committing to a what they called "capital restoration” for the institutions.
A former official involved with both groups estimated the cost at $US300 billion in an interview with Bloomberg.
But this is a two year bailout, so the really hard decisions have been left to the new US President and the new Congress.
First up the two mortgage giants will be right-sized and enough money waved at them to settle market nerves.
Markets around the world bounced yesterday on the news of the biggest bailout anywhere in the world. Soon though, investors will wake up to the fact that the US economy is slowing and heading towards a nasty recession.
Those home loan arrears and foreclosure figures are doing the real damage.
At best the US Government has bought time to allow Fannie and Freddie to be revamped to provide some support to the battered housing sector. It remains the black hole that is pulling everything in after it.
Fannie and Freddie’s problems spring from the tanking housing sector, not the other way round.
All the moves are the latest and last in a series of moves that sees the entire US economy on Government life support.
The Fed is lending US commercial banks more than $US17 billion a day and the Fed’s Term Auction facility is a semi-permanent overdraft at the moment for the entire financial system worth a continuing $US150 billion.
And remember, the Fed is spending or providing $US30 billion making sure the rescue of Bear Stearns will work. That was March’s bailout and supposed to draw a line in the sand.
But it’s not just the huge US financial system that is being kept afloat: through arrangements with the European Central Bank and the Swiss National Bank, the Fed is helping fund the banking and financial sectors there to the tune of tens of billions of dollars a day.
The ECB is also pumping billions of its own money into the European financial system as is the Bank of England.
What’s happening in the US and Europe emphasizes the very real strength of the Australian economy and the Australian financial system despite all those nervous nellies obsessing about debt levels here.
Yes they are a problem, but we have cash to burn in our banks and it is being lent. The US has no cash and none to lend, except from the Government teat.
RBA Governor Glenn Stevens said yesterday that Australian banks were much better placed than their international counterparts.
"But they are showing more caution now," he told the House of Representatives Economics Committee hearing in Melbourne.
But our banks are solvent and able to stand independent of any support from the RBA. You can’t say the same about banks in the US, Europe or the UK.
Despite the ‘support’ legislation of two months ago by the US Government, the final move was brought on by growing distaste for Fannie and Freddie debt (and for that associated with the home loan banks).
As well a complete investigation of Fannie and Freddie’s accounts showed legal, but questionable accounting moves that overstated their capital, particularly Freddie, which may have gone close to failure in the December quarter of this year.
On top of that, major foreign buyers of Fannie and Freddie debt, including Russia and China, had been cutting back on their previous large purchases.
Fannie and Freddie have $US5.4 billion in outstanding liabilities, mostly guarantees on mortgages: these were at risk, which in turn put the entire US financial system and that of the rest of the world at risk given that central banks (Russia, China), banks and other investors own hundreds of billions of dollars worth of debt issued by the two groups.
Holders of shares and preferred shares in the two groups will be severely diluted to the point where the ordinary shares- down more than 60% this year and 20%-32% in a few minutes trading late Friday- will be worthless.
The loss of value on the $US36 b
