Fannie Mae and Freddie Mac were nationalized in August, and while that was horrific enough standing alone, I said at the time that the real horror would come in the government's new uses for the two mortgage giants.
News crossed this morning of a new program from the Federal Reserve to buy $500 Billion in mortgage backed securities from Fannie and Freddie and another $100 Billion of their debt. This is just the first buyback of many to come, but what does that mean to the real estate market?
We created a bubble in real estate because lenders were essentially allowed to make a home loan to anyone. This allowed more entrants into the market and more importantly a lot more speculators. Lenders could lend this way because they immediately sold the loans into the secondary market, and the secondary market then packaged those loans and sold them to the world.
The problem is that a very large portion of those loans are now going bad and investors around the world are taking tremendous losses. In a sane world, that would mean that they would not buy any more mortgage securities at the current bubble prices that Americans cannot afford to pay. That would mean that lenders would have to keep the loans on their books, and they would have to make only loans they felt would be safe and would not default.
This means homeowners would again have to put down 20%, have a job, ect. In order for homeowners to be able to do that home prices would have to collapse back down to an affordable level. That is the way a free market works, but the government will not let the natural market forces work.
What will happen now is that lenders will continue to make loans that are bad as long as they have the ability to immediately sell those loans to Fannie Mae and Freddie Mac. They are currently the only ones left to buy the toxic debt at bubble prices. The problem is that Fannie Mae and Freddie Mac now have to figure out a way to unload that toxic debt off of their balance sheet. The new Fed program provides the answer. They now buy the toxic debt and print new dollars to exchange with Fannie and Freddie.
I was watching CNBC this morning and they were laughing and smiling and one of anchors asked the other, "What comes after $999 Trillion, so we know what to call it when the bail out gets there?" The other one laughed and said I think it is a quadrillion.
The laughing will come to an end probably somewhere around 2010 when they realize what a trillion printed dollars does to a currency. Some people will be laughing, it will be the ones that understand today what effect it will have on our future.