Important:Economy Issue 7-11-08: Both Sides Of The Mouth

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Subject: Issue 7-11-08: Both Sides Of The Mouth

From Tom Harvey - Author
and Cyrus Uible - technical guru.
 
 Stocks crashed today on the bad news coming out of Fannie Mae and Freddie Mac (see analysis below)....
Talking out of both sides of the mouth.....

The stock market was rattled today by the news that Fannie Mae and Freddie Mac were in deep trouble financially.  Their share value was off 49% and 46%, respectively, early this morning on the news.  (Consider losing half of your stock market investment in an hour's time, and you get a feel of the meltdown going on.)  Part of the news was that the government was considering taking over these Government Sector Enterprises (GSE's) as part of a contingency plan.

Paulson then said there would be "no government bailout", and the government would "support them in their current form."

Sen. Dodd, after talking with Paulson and Bernanke, then said there may be federal help for these GSE's.

All in the same day.  Sounds like conflicting statements on the surface!!!!!!!  My interpretation is that there is PANIC inside the government on this issue.  This smells too much like the Bear Stearns weekend, and I would not be surprised to see something BIG happen on Sunday (the same day of the week that Bear Stearns was rescued.)

Well, let's look at the facts, and come up with our own conclusion.  Clearly Fannie and Freddie are in trouble financially.  Together they hold about $5 Trillion worth of mortgages.  That's a VERY BIG NUMBER.  Even if a very small percentage of those mortgages were to go bad (and going bad is a reality, not a guess), the loss to the GSE's would be catastrophic.  Think bankruptcy for a normal company.

Allowing Freddie and Fannie to go bankrupt is not the decision of the FED or the Treasury. There are BIG political overtones here, and the Congress is the body that would step in and save the day.  The Congress set up these GSE's in the first place (and the G in GSE stands for Government), so they aren't about to let them fail in a Presidential election year.  The Congress would try to strong arm the FED and/or the Treasury into taking action to save these GSE's.

So, the logical conclusion is that YOU are going to bail out Freddie and Fannie. The FED will probably step in, and use those lousy mortgages as collateral  for new loans to these GSE's.  That's what they've been doing with the merchant banks, so what's different here???  The FED's preferred tool is the Discount Window.  The FED could make a statement that the public won't lose any money because these mortgages will ultimately pay off.  When you hear that statement, get scared.  It means YOU are really stuck with the bill in the long run.  Probably it will not only be YOU, but also your CHILDREN and GRAND CHILDREN.

When it comes time to pay the bill, the FED will simply print more money; and by print more money, I mean increase the M3 measure of currency.  Conveniently M3 is no longer being published officially, but other people continue to monitor its growth, and it is currently growing at 16%/year.  (Not coincidentally, I believe the real inflation rate for consumers is around 8% to 10% - so you can see the influence of M3 on inflation.)  So the M3 growth rate will increase, and inflation will increase with it.  One of the unanswered questions is "When will the rest of the world stop buying US Treasuries, and keeping the US Government afloat?"

This is an example of the type of logic and thinking that I want every EconomyGuy reader to be able to do whenever they hear this type of news.


Here are today's numbers:
Dow Jones 30 Industrial - 11229 (up 82 points)
10 Year Treasury Bond - 3.81% (down 0.02%)
Euro - $1.5788
Gold - $942 (up $13)
Oil - $141.65 (up $5.60) - back with a vengeance.
Gasoline - $3.51 (up $0.13)