Unfortunately, we Americans now realize that the decision by Ben Bernanke to slash the Fed Funds rate to 2% (a three hundred twenty five basis point reduction) was just the opening act in this Republican administration’s socialism play. At the time some wondered why the government didn’t just allow home prices fall to historical averages rather than seeking to lower the value of the U.S. dollar and send inflation to a 17-year high. Now we have learned just this past weekend that the Department of the Treasury has come up with a plan for conservatorship of the GSEs, enacting the largest bailout in the history of the United States.
What does the conservatorship plan mean? It means the government will take over the GSEs for the purpose of continuing their operation rather than putting them into receivership, which would seek to sell off their assets and shut down future business. In contrast, the Paulson plan will actually increase the holdings of FNM [“Fannie Mae”] and FRE [“Freddie Mac”] by $144 billion. The total of mortgage backed securities held by the GSEs will be allowed to increase to $850 billion each by December 2009.
My Libertarian heart sank when I witnessed Republicans and Democrats slap each other on the back as they congratulated themselves from saving us from the natural workings of the free market. The Republicans reek of hypocrisy, claiming the bailout of FNM and FRE was necessary for the health of the real estate market and the economy. I guess government intervention in the free market is only mandatory if you’re a bank, insurance company, foreign government or a pension fund that owns GSE debt.
It was especially telling when Hank Paulson’s was asked in a CNBC interview how much his bailout plan will cost taxpayers. He responded that he “did not use a calculator” when putting together this scheme. The essence of his response was that he did not care what the bill to taxpayers would be, his main concern was to recapitalize banks and stop home prices from falling.
The big problem with this plan is that the government does not have a plausible exit strategy. After Treasury has taken the companies into conservatorship and then expands their operations, it will not be easy to reduce the size of the GSEs. Their intention is to wind down the agencies balance sheets beginning in 2010 at a rate of 10% per annum until they reach just $250 billion each. So let me get this straight, after the real estate market has become more reliant on FNM and FRE to securitize the mortgage market, we will then be able to allow market forces to take hold? That view becomes especially dubious in light of the fact that we will have a new administration in charge when this scale-down is supposed to be taking place.
Just as the U.S. has become addicted to artificially low interest rates–unable to raise them without seriously hurting the economy– we now have most likely permanently socialized a good portion of the real estate market and the economy. Does the administration really believe that it is better to debase our currency and greatly expand the obligations of our government rather than letting home prices fall to a level that can be supported by the market? This move has long-term ramifications on the dollar and the national debt. Thanks to a stimulus package and reckless spending from the administration, annual deficits are already skyrocketing to nearly $500 billion. Now with the Paulson bailout plan, debt could increase even faster. This may torpedo the recent move higher in the dollar and makes its long-term picture even more bearish.
Perhaps it will first fall even further in coming weeks, but the need to own honest money (gold) never been more apparent. – Michael Pento, Senior Market Strategist, Delta Global Advisors
JWR Adds: Be sure to check out Michael’s podcast, The Mid-Week Reality Check.