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August 28, 2008

GSEs: Too Big to Survive
by Michael Pento

Wall Street's recent mantra -- emblematic of its support for bailouts, especially of financial firms -- is that Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) are too big to fail. I've written before about the potential problems associated with the G.S.E.s, but it is now quite clear how much trouble these companies are in, so I thought it was time to write a follow-up.

We have all heard the expression "The road to hell is paved with good intentions." At no time has that statement been more apropos than with the creation of Fannie Mae and Freddie Mac. Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt's New Deal, while Freddie Mac got its start in 1968. Like most government sponsored programs, the idea sounded ok to most people. The concept was to help expand home ownership by facilitating bank securitization, i.e. offering government-backed insurance to bond holders in the case of a principal or interest default. The business of the Fannie Mae later expanded to raising funds with an implicit government backing, and hence lower interest rate, to purchase mortgages outright and hold them as an investment.

So far so good, right? I mean, shouldn't the public sector strive to put as many people in the role of home ownership as they can? Wrong! That's where I find myself wondering how the Republicans have gone so far astray from embracing capitalism. I don't expect Democrats to rail against a program that they themselves enacted but why we have Hank Paulson, George Bush and Ben Bernanke doing back flips to keep these institutions alive is beyond me. Those republicans, folks who are supposed to espouse free market concepts, should be asking why the government was meddling in the mortgage business to begin with.

This administration doesn't seem daunted at the fact that FNM and FRE have reported a loss of nearly $15 billion in the last 12 months alone. Instead, it finds itself in lock step with Congressman Barney Frank (D-MA) who wishes to expand G.S.E. powers in order to rescue the real estate market. In my view we have already crossed the Rubicon in regard to the G.S.E.'s. These monsters now are responsible for 80% of all new mortgages created in 2008 and own or guarantee a total of 42% of the $12 trillion dollar mortgages outstanding. The time to shut down the expansion of the G.S.E.s' is now. We may already have reached the point where the entire real estate market and consequently the economy are beholden to the government's continued involvement in the mortgage market. Their role now should be to allow FNM & FRE to exist only to the point that they can pay off existing debt holders while making sure they cease writing new business.

When government decides to meddle with free markets, imbalances occur which causes capital to be deployed in ways that are economically unviable and unsustainable. A continuation of such behavior--especially to the degree that FNM & FRE have reached--can lead to massive increases in inflation and a painful economic unwinding.

We Americans have come to believe that suffering the consequences of our loose lending and monetary policies can be avoided by escalating those same practices, but we cannot succeed in reconciling an economic imbalance by fostering its continuation. The truth is we have allowed these G.S.E.s' to become too big to survive and our government must seek to eliminate them rather than continue to pursue the idea that through these entities, politicians can effectively divine what percentage of the population should own a home.

*Please check out my podcast, The Mid-Week Reality Check

Michael Pento
Senior Market Strategist
Delta Global Advisors, Inc.
800-485-1220

With more than 16 years of industry experience, Michael Pento acts as senior market strategist for Delta Global Advisors and is a contributing writer for GreenFaucet.com. He is a well-established specialist in the Austrian School of economic theory and a regular guest on CNBC and other national media outlets. Mr. Pento has worked on the floor of the N.Y.S.E. as well as serving as vice president of investments for GunnAllen Financial immediately prior to joining Delta Global.

Copyright © 2006-2008 Delta Global Advisors, Inc.

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