Fannie Mae/Freddie Mac Meltdown?!? [View All]

Government-sponsored Fannie Mae (FNM) and Freddie Mac (FRE) own about 75% of the mortgages in the US, which amount to trillions of dollars. I've heard some wonderful Armageddon scenario from that crazy LaRouche camp, that there is a bubble in housing/mortgage prices that will pop and take down major banks and world economy.
http://www.larouchepub.com/other/2002/2924fannie_mae.html

I thought I'd try to see if this was plausible. It turns out they aren't the only ones out there being alarmist about this. Correct me if I make any mistakes but this is how it supposed to work:

1) You put your money in the bank.
2) They're allowed to reinvest a certain fraction of this money in the private sector (for FDIC).
3) They lend money in the form of a mortgage.
4) They sell this mortgage to a GSE (Fannie Mae or Freddie Mac).
5) They buy from the GSE bonds or Mortgage Backed Securities. These securities like government bonds don't count toward their fraction of assets they may invest in the private sector.
6) They loan more of your money out in a new mortgage (go back to 3).

I suppose they can do this until most of your money is invested in mortgages (fed reserve limit?). Whether GSE securities are backed by Uncle Sam is an open question. The market seems to think they are in pricing GSE securities. Right wingers like Cheney seem to want to say no, that the government should assume no responsibility.


Let's look back at what caused the great bank collapse that started the great depression? Banks hand no restrictions on how much money the could reinvest in the private sector.

1) You put $100 in the bank.
2) They loan it to Alice.
3) Alice pays Bob to do something.
4) Bob puts $100 in the bank (goto 1).

At some point in time You and the Bobs have the bank owing each of you $100, but there was only ever one $100. You run on the banks: the first one gets the money; the bank goes under; the rest get screwed!!!


Let's look at the GSEs and the major banks participating in this as a system S.

1) I put my money into the bank or fund. In other words I put money into S.
2) S loans much of it out as mortgages.
3) This money builds houses, pays workers, and goes into circulation.
4) It eventually goes into a bank or fund. (goto 1)

Now is this like the great bank collapse example? It's not quite as obvious, because S owns a ton of mortgages and those are backed by real property. However property values could fall, if they start foreclosing mortgages to pay off their debts. The money has to come from somewhere. If the economy starts failing and people can't pay their mortgages, and nobody wants to buy houses, it seems to me like S would fail.

I'm not 100% convinced of this analysis. It also seems to me like their complaints about the derivatives traded within S are red herring.


Here are some articles that point to this same phenomenon:
A Housing Collapse Could Wound the Banks
http://www.businessweek.com/magazine/content/01_36/b3747050.htm
Fannie Mae, Freddie Mac Say Collapse Unlikely
http://blogcritics.org/archives/2004/02/29/230718.php
Fannie Mae and Freddie Mac: Fear Not
http://www.businessweek.com/bw50/content/mar2002/a3776032.htm
A Microeconomic Analysis of Fannie Mae and Freddie Mac -- Cato doesn't think there's a danger
http://www.cato.org/pubs/regulation/regv23n2/vanorder.pdf
Freddie Mac and Fannie Mae: The time to panic is now
http://www.montanastandard.com/articles/2004/02/28/newsopinion/hjjfjhhcjjfgei.txt
Fannie Mae Distorts Markets
http://www.mises.org/fullstory.asp?control=986


Are housing prices inflated because of this?
Is there a serious risk of a big bubble popping here?
Does anyone else have a better understanding of thing?