Tuesday, July 21, 2009

$24 Trillion

Bloomberg reported this morning that special inspector general Neil Barofsky has just completed a recent accounting of the Government's liability in "backstopping our financial system." His conclusion:

"Under the worst of circumstances, the report said, the government's maximum exposure could total nearly $24 trillion, or $80,000 for every American."

http://news.yahoo.com/s/ap/20090720/ap_on_go_ca_st_pe/us_meltdown_oversight;_ylt=Aj1nmyXHiHchMHNchufLiFCyBhIF;_ylu=X3oDMTM1Z3VtZ25nBGFzc2V0Ay9hcC8yMDA5MDcyMC9hcF9vbl9nb19jYV9zdF9wZS91c19tZWx0ZG93bl9vdmVyc2lnaHQEcG9zAzQEc2VjA3luX21vc3RfcG9wdWxhcgRzbGs

Yep, $24 trillion.

Now, before we continue it is important to understand what that number means. The government will never have to raise that amount of capital.

For example, the government took over Fannie Mae and Freddie Mac in August of last year. With that decision, the government was now backstopping $6.8 trillion in liability. ($6.8 trillion is part of the sum $24 trillion) Now, in order for the taxpayer to have to fund $6.8 trillion, every loan on Fannie and Freddie's books would have to have a value of $0. Obviously this would not happen, as homes will ultimately sell at a price above $0. (We hope)

So the question is, how much of that $24 trillion will the taxpayer have to come to the table with. Lets take a look again at Fannie and Freddie.

If we as a country now own $6.8 in mortgages and mortgage guarantees, how much of that do you believe will end up as losses? Well, that depends on your outlook of the housing market. My personal outlook is that the housing market is headed toward oblivion.

But lets take a more "optimistic" view and say that the value of that debt only falls by 10%. That means the government will have to raise $680 billion to keep Fannie and Freddie solvent.

That is only one half of the story, however. Right now the only person/investor/business stupid enough to lend money to Americans to buy a home at these interest rates is Fannie Mae and Freddie Mac. The government has now become the only lender.

It is for this reason that the Federal Reserve announced in March that it will be purchasing $1 trillion in mortgage backed securities.

Here is the order of the operation:

1. You go to your bank to get a loan for a home.
2. The bank lends you the money and then sells that mortgage to Fannie Mae or Freddie Mac for a fee.
3. Fannie Mae or Freddie Mac then sells that mortgage to the Fed, and the Fed holds that mortgage on their balance sheet.

This is how these government lenders will stay solvent.

It is also why when Ben Bernanke told Ron Paul this morning during his testimony that he has no intention of "monetising" our debt, it is a laughable notion. He has already told us he will.

Along with the $1 trillion in mortgage purchases he announced in March, he announced the purchase of $300 billion in treasury debt.

Both of these amounts are down payments. If the government wants to keep the housing market from imploding they have to keep buying the mortgages. This means that Fannie and Freddie's balance sheets will mushroom to close to $10 trillion in the coming years.

At the same time the $24 trillion news was dropped on the markets this morning we received another insight into the global economy:

HEADLINE: "From left field, Brazil, Canada pull money out of Treasurys"

"Brazil and Canada were among big sellers of Treasurys in the latest month for which data is available and the previous year, catching analysts off guard and raising speculation that quieter nations may be concerned about investing in the U.S."

http://www.marketwatch.com/story/brazil-canada-pull-money-out-of-treasurys

This means that while Obama continues to pile trillions on our backs with new spending, and tax receipts continue falling rapidly as the economy disintegrates, our foreign lenders are slowly stepping away from the party.

Much more on that to come.

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