Investors here understand the nature of relief rallies by now. As dramatic as the increases were, led by Australia and Asia and finished off in the US, there's a long, long way to go for the two mortgage groups and for the financial systems not only of the US, but Europe and the UK. Like or not the moves to bail out Fannie and Freddie once again remind us that the financial systems of the world's two major economic powers, the US and Europe, are effectively on life support, with most of the money coming from the battered US Government and Federal Reserve.
Without the series of moves by the Fed and US Governments this year, the world economy would be in crisis. The life support system was completed when the US government staged an unprecedented and wide ranging bailout of the country's tottering financial system with a $US200 billion plus deal to take control of the tottering mortgage giants, Fannie Mae and Freddie Mac. As well 12 Federal Home Loan Banks will be given a liquidity lifeline to prevent their failure.
US banks and other financial groups who hold most of the $US73 billion of preferred shares issued by Fannie and Freddie will not be allowed to fail if they suffer losses as the preferreds lose value and in turn destroy their capital reserves, with the Fed and three leading US bank regulators committing to a what they called "capital restoration'' for the institutions.
A former official involved with both groups estimated the cost at $US300 billion in an interview with Bloomberg. But this is a two year bailout, so the really hard decisions have been left to the new US President and the new Congress.
First up the two mortgage giants will be right-sized and enough money waved at them to settle market nerves. Markets around the world bounced yesterday on the news of the biggest bailout anywhere in the world. Soon though, investors will wake up to the fact that the US economy is slowing and heading towards a nasty recession.
Those home loan arrears and foreclosure figures are doing the real damage. At best the US Government has bought time to allow Fannie and Freddie to be revamped to provide some support to the battered housing sector. It remains the black hole that is pulling everything in after it. Fannie and Freddie's problems spring from the tanking housing sector, not the other way round.
All the moves are the latest and last in a series of moves that sees the entire US economy on Government life support. The Fed is lending US commercial banks more than $US17 billion a day and the Fed's Term Auction facility is a semi-permanent overdraft at the moment for the entire financial system worth a continuing $US150 billion.
And remember, the Fed is spending or providing $US30 billion making sure the rescue of Bear Stearns will work. That was March's bailout and supposed to draw a line in the sand. But it's not just the huge US financial system that is being kept afloat: through arrangements with the European Central Bank and the Swiss National Bank, the Fed is helping fund the banking and financial sectors there to the tune of tens of billions of dollars a day. The ECB is also pumping billions of its own money into the European financial system as is the Bank of England.
What's happening in the US and Europe emphasizes the very real strength of the Australian economy and the Australian financial system despite all those nervous nellies obsessing about debt levels here. Yes they are a problem, but we have cash to burn in our banks and it is being lent. The US has no cash and none to lend, except from the Government teat.
RBA Governor Glenn Stevens said yesterday that Australian banks were much better placed than their international counterparts. "But they are showing more caution now," he told the House of Representatives Economics Committee hearing in Melbourne.
But our banks are solvent and able to stand independent of any support from the RBA. You can't say the same about banks in the US, Europe or the UK. Despite the 'support' legislation of two months ago by the US Government, the final move was brought on by growing distaste for Fannie and Freddie debt (and for that associated with the home loan banks).
As well a complete investigation of Fannie and Freddie's accounts showed legal, but questionable accounting moves that overstated their capital, particularly Freddie, which may have gone close to failure in the December quarter of this year. On top of that, major foreign buyers of Fannie and Freddie debt, including Russia and China, had been cutting back on their previous large purchases.
Fannie and Freddie have $US5.4 billion in outstanding liabilities, mostly guarantees on mortgages: these were at risk, which in turn put the entire US financial system and that of the rest of the world at risk given that central banks (Russia, China), banks and other investors own hundreds of billions of dollars worth of debt issued by the two groups.
Holders of shares and preferred shares in the two groups will be severely diluted to the point where the ordinary shares- down more than 60% this year and 20%-32% in a few minutes trading late Friday- will be worthless.
The loss of value on the $US36 billion of preferred shares issued by both will be cut sharply, which in turn will trigger losses for a group of small and regional banks, plus other financials. US regulators will work with them to raise more capital to prevent any unwanted collapses.
The two will be run as private companies, but will be directed to cut fees (recently increased) to help bring down the cost of mortgages. They will be encouraged to finance more mortgages until the sector is stabilised.
The Government will inject up to $US100 billion in each of them as needed to ensure they meet their debts. In addition, it would start buying mortgages backed by these companies and extend an unlimited liquidity facility to them until the end of next year.
The US Treasury will also extend financial support to 12 federal Home Loan Banks that are essentially state owned co-operatives operating in the private sector. They have a further $US1.3 trillion in assets and will be given short term financial support for as long as possible to ensure they continue lending money.
The bill is astronomical: easily $US1 trillion all up in losses, new capital injections and US Government and Fed support. Plus there's the support from the ECB and the Bank of England which is in the tens of billions of US dollars a day. And there're the stockmarket losses. Estimates put those at more than $US12 trillion since last August.
The actual size of the bailout and support is hard to quantify: $US200 billion for Fannie and Freddie, plus other deals, liquidity support for the home loan banks and for private banks and insurers hurt by the loss of value in Fannie and Freddie shares; $US150 billion every 28 days from the Fed: $US17.5 billion for the banks every day, plus billions swapped with the ECB and the Swiss central bank.
And this is on top of the half a trillion of losses already suffered from the credit crunch and subprime meltdown: and there's also the $US350 billion in fresh capital raised by private sector banks, insurers and other investors.
There's also billions of dollars in losses among state government and individual investors from things like auction rate notes collapsing; cash management fund losses and top ups for the companies and investors involved, and the failures of hedge funds and mortgage brokers and issuers tops the $US150 billion with loses on various forms of investment and cash funds.
The losses are enormous: Deutsche Bank has 'escaped' lightly with $US10.3 billion, HSBC, $US27.3 billion, GMAC over $5 billion, GE Money, several billions, UBS, Citigroup and Merrill Lynch: $US130 billion between the three of them. 11 banks have failed in the US this year: total; cost over $US45 billion. And there was the $US 30 billion spent rescuing Bear Stearns in March.
In Australia; perhaps $3 billion with the National Australia Bank the biggest loser with $1.1 billion on Collaterallised Debt Obligations and another $1 billion or so in three hedge funds that failed, including basis Capital last year. Rams Home Loans failed and was bailed out, while we have seen over $6 billion in losses from groups like Allco, Babcock and Brown, Centro and others as a result of the credit crunch, but not associated with the US housing collapse directly and the subprime CDO mix.
You can see that without the lifelines from the Fed, the US Government and also the ECB and the Bank of England, the world economy would be going to hell in a hand basket very quickly: it would be a case of 'Hello 1932'.
