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Here Comes the Next Phase of the Financial Crisis   December 29th, 2009
Are we post-crisis or mid-crisis?       

 
QUICK OBSERVATIONS

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Many of us have suspected for some time that the financial crisis has yet to play out entirely. Despite numbers that, perhaps temporarily, might suggest some kind of a recovery, there are many things going on that could yet be the equivalent of a financial nuclear bomb.

Dollar devaluation, overwhelming government debt, an alternative reserve currency, pricing oil in some other currency, too much government spending and related massive deficits, asset bubbles, easy money, and the potential end to government support of low interest rates and mortgage backed securities, to name just a few.

It seems to me in the last few days we've seen two potential big red flags about what the future holds.


First, it was announced today that GMAC will be receiving another $3.5 billion in aid from the Federal Government:

GMAC Financial Services is close to getting $3.5 billion in financial aid from the U.S. government, according to a Wall Street Journal report Tuesday citing people familiar with the situation. The package, which will supplement $12.5 billion in government support already received by the Detroit-based finance company since December 2008, is expected to be announced within days, the report said. GMAC is also expected to announce in coming days additional steps to absorb losses related to its mortgage operations, the report said.


So we have GMAC apparently requiring another $3.5 billion beyond what it already received, and it will announce additional measures to absorb mortgage-related losses.

We also have the Treasury announcing that Freddie Mac and Fannie Mae basically have a blank check in terms of government bailouts:

When the Treasury Department took over Fannie and Freddie last year, one of the requirements they set for the companies required them to begin shrinking their portfolios of mortgages and related investments, which total a combined $1.5 trillion. The idea was to rein in the companies' size and growth.

But last Thursday, the Treasury eased that requirement, meaning the companies won't be forced to sell mortgages into an already weak market and could even buy mortgages on the market, which could help hold down interest rates. The Treasury also suspended for the next three years the $400 billion cap on the bailout subsidy that the government will offer.


So we have the government moving to make the sky the limit in terms of federal support for these two entities.

More bailouts for GMAC, apparently to help them deal with mortgage-related losses. And a blank check for mortgage-giants Freddie Mac and Fannie Mae.

Does this really give you the impression that the administration thinks the worst is over? I don't think so.

    Update 12/30/2009: Another article is making the same point as I made--what do these actions tell us about what the administration really think is in store for the economy?

    This decision is evidence enough that the bailout brigade continues apace, even as Obama Administration spokesmen and Federal Reserve officials insist that the worst is behind us, and that the economy has already technically emerged from recession. What, we may well enquire, could worry government insiders so much about the economic future that they felt obligated to remove all further restraints on government bailouts to the two biggest players in the imploded mortgage industry? After all, the government has spent barely a quarter of the funds already available to bail out Fannie Mae and Freddie Mac.


Interestingly, I wrote last month that a big potential problem is that the Federal Reserve is planning on winding down its mortgage-backed security purchasing program at the end of the first quarter. As I mentioned, removal of the Fed's purchase program would tend to put upward pressure on interest rates. I suggested that it was possible they'd try to kick the can down the road by extending the program.

However, it's looking like maybe the Fed won't extend it... it will just transfer that task to Freddie Mac and Fannie Mae:

Others said the new flexibility means that Fannie and Freddie could replace the Fed as a big buyer of mortgage-backed securities, especially if weak demand for mortgage-backed securities from private investors drives rates higher.

"It's created a government-purchasing facility other than the Fed," said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a research firm in Washington.


In other words, it looks like there is an attempt underway to transfer this program from the Federal Reserve to the Federal Government by way of Freddie Mac and Fannie Mae's unlimited government support.

But the government doesn't have any money! Any money that it uses to support Freddie Mac and Fannie Mae must either be borrowed from China or printed by the Federal Reserve. China's running out of money to loan us and the Federal Reserve supposedly already turned off the printing press--and if it turns it back on, why not just extend the MBS purchase program?

Is this a situation where the Fed and/or the administration wants to generate a perception that things are getting better based on the assertion that the Federal Reserve is no longer printing money and buying mortgage backed securities, but accomplishing that by doing essentially the same thing with Freddie Mac and Fannie Mae?

One thing's for sure: The bailouts seem to be starting up again. GMAC got an extra few billion and Freddie Mac and Fannie Mae now have an open-ended commitment from the government. Recall that the last time Freddie Mac, Fannie Mae, and the U.S. Government made big news together was about two weeks before the September 2008 financial crisis.

This is an absolutely dizzying, convoluted, amazing mess and it's looking increasingly doubtful that it's going to have a happy ending. It's not clear what's about to play out, but these aren't the kind of actions that are necessary under normal circumstances.

I wrote last month that I was concerned about the first quarter or two in 2010. Now I'm even more concerned.

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