Mortgage Crisis:
Two Giants Shaking

Jul 14, 2008

Even before the IndyMac takeover, the whole financial market had already been shaking last week with anxiety over the fate of Fannie Mae and Freddie Mac, two mortgage companies that together own or guarantee five trillion dollars worth of mortgages, or about half the outstanding mortgage debt in the U.S.

Fannie May and Freddie Mac were set up by the federal government, but operate as private stock companies. They buy mortgages from banks which make the loans to home buyers. Then Fannie and Freddie bundle the mortgages and sell them again, to buy new mortgages with the money they get.

Lately the two companies have been reporting big losses–about eight billion dollars in the last nine months. And serious economists have started to bring up the possibility that one or both of these mortgage giants may declare bankruptcy–something that would have been unthinkable just a few weeks ago.

The stock prices of these companies have been falling fast–and that already has had big consequences. Fannie Mae and Freddie Mac bonds have long been considered among the safest, and many big banks and governments throughout the world own a lot of them. The fact that both companies’ stock prices fell by 50% last week threatens huge financial losses for big companies and governments.

But also, many big banks and corporations are deeply submerged into the mortgage market–and thus linked to Fannie and Freddie. It is estimated, for example, that J. P. Morgan holds a total of 87 billion dollars worth of mortgage securities and mortgage debt backed by Fannie and Freddie. Another U.S. banking giant, Citigroup, is thought to hold 51 billion dollars worth of the same.

In short, a failure of Fannie Mae and Freddie Mac would shake the financial markets throughout the world, and possibly bring down giant banks and corporations–indeed the functioning of the whole capitalist economy.

There are crucial questions, whose answers are anybody’s guess. For example, everybody knows that many more of the outstanding mortgages will default in the future, but how many? And how many of those bad loans are owned or guaranteed by Fannie and Freddie? Nobody knows.

Secondly, how long will the confidence of individuals, banks and investors last, so that they continue to buy and sell mortgages and company shares, issue loans, etc.? There is already a lending crisis, because many banks have stopped giving each other loans for fear of not getting their money back.

As far as the stock market can be seen as a measure, things don’t look good. Last Friday, Fannie and Freddie shares went down sharply by 50% within minutes, before gaining some by the end of the day. Then came the IndyMac takeover, and the news that Freddie is due to sell three billion dollars of short-term debt on Monday. Depending on whether there will be buyers at all, or if the government will be able to persuade banks to do that (for the sake of keeping the whole system afloat), next week may prove to be a crucial one.

But if next week goes by without some huge crash in the markets, what will happen the following week? And the week after that? How long will these huge companies be able to stay afloat?

Government and company officials try to act cool and confident–as if things were stable and under control. But, more and more, they look like the guy who whistles loudly going by the cemetery at night, when the ghosts are ready to jump.

The only thing that’s certain is that the banks and “investors,” whose unsatiable greed created the whole mess, will do everything they can to make working people foot the enormous bill–and that government officials will try to make taxpayers’ hard-earned money available to them.