Is gold going to $6,300? Dylan Grice, an analyst with Societe Generale, says it’s possible, given the decline in central bank credibility. But investors need to keep one thing in mind: Gold is merely a vehicle to protect the purchasing power of money.

Gold is surging because investors see that the Federal Reserve — more concerned with deflation and unemployment than sound money — may be trapped in a never-ending cycle of monetary accommodation.

Ben Bernanke says he won’t monetize debt, but he already has. His Fed has bought $300 billion of Treasuries and is on pace to buy $1.45 trillion of government-backed mortgage debt all of which is being salted away indefinitely on the Fed’s balance sheet.

Why indefinitely? Because the Fed has no intention of unwinding its balance sheet so long as the economy is stressed. Witness comments this week from Bernanke, Fed Vice Chairman Don Kohn and San Francisco Fed President Janet Yellen all suggesting that the Fed’s “extended period” of low interest rates can be measured in years, not months. Today St. Louis Fed President James Bullard said rates aren’t going up till 2012.

So long as deficit spending continues, if the Fed wants to avoid deflation, it will be forced to monetize more debt.

[Elsewhere, capital controls are being erected in emerging economies like Brazil, Taiwan, and possibly Indonesia in order to keep speculative waters at bay. As Hong Kong's chief executive remarked last week, a dollar carry trade spawned by low rates threatens to inflate dangerous asset bubbles in emerging markets the same way low Japanese rates did in the '90s.]

Exploding debt throughout the developed world means other central banks face similar pressure.

(Click chart to enlarge in new window, reprinted with permission)

So confidence in paper currencies is waning.

Some people say it is absurd to buy gold; the metal has no intrinsic value. That may be. But is it any less absurd to hold paper? The best that can be said for paper is that if you lend or invest it, tomorrow someone will give you more paper in return. This is fine so long as its purchasing power is maintained. But it isn’t. A 2009 dollar is worth a 1914 nickel.

Eventually the value of all the paper you’ve accumulated goes to zero. The trick is to turn that paper into tangible assets with tangible value.

Gold may be volatile, but at least it maintains its real value:

(click chart to enlarge in new window, reprinted with permission)

Grice contends that the price of gold could reach $6,300 an ounce. He explains: “The U.S. owns nearly 263 million troy ounces of gold (the world’s biggest holder) while the Fed’s monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap — at current prices, the USD is only 15 percent gold-backed.”

Absurd you say? It happened 30 years ago. President Nixon ended the Bretton Woods global monetary system and his compliant Fed Chairman Arthur Burns let inflation run wild. So by 1980 gold spiked to a level at which the dollar was “overbacked” according to Grice.

Did gold overshoot in 1980? Sure, but only because Paul Volcker was willing to hammer the economy to re-establish the Fed’s credibility. Today’s Fed has been very clear that it isn’t willing to put up with a recession of any kind in the service of sound money.

All of that said, investors should be careful. Grice’s chart shows that, over the long run, gold is likely to do no better than protect your purchasing power. An ounce of gold today buys a good men’s suit; in 100 years, it is likely to buy the same.

So gold won’t make you rich. But it may protect you from becoming poor.

Bartiromo asks some good questions, including “are banks adequately capitalized today?”

“No way” says Whitney.

She adds: “I don’t know what’s going on in the market right now ‘cuz it makes no sense to me.” The fundamentals aren’t there.

(ht Alexis N.)

Rick Bookstaber announced on his blog yesterday that he will joining the SEC’s “Division of Risk, Strategy and Financial Innovation.”

This is a welcome development. Bookstaber is the author of A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.

He was part of an Oxford-style debate on that very subject at the Economist’s Buttonwood Gathering last month. I was lucky to be in the audience. Below is the video. (Here’s a link too…..go to “debate on financial innovation.”)

Watch it through just to see Jeremy Grantham. He was on fire. (His first comments being a third of the way in.) His rhetoric successfully flipped the audience from being 80:20 in favor of the proposition that “financial innovation boosts global growth” to a similar margin against.

It’s highly ironic that Myron Scholes was chosen to argue for the proposition. An inventor of the Black-Scholes options pricing model, he was also a partner at LTCM, the famous hedge fund firm that blew itself up mixing mathematical hubris with leverage.

Scholes’s life story should be a cautionary tale AGAINST the idea that financial innovation creates great wealth. Yet here he is, having learned nothing.

Not that it’s unexpected. Nothing encourages cognitive dissonance quite like the absence of consequences. Bailed out bankers on Wall Street who feel they’ve “earned” the bonuses they plan to pay themselves this year are just the latest example…

Do you think we should establish a government-backed insurance fund for big banks’ risky trading activities? Probably not. But that’s precisely what the administration and Congress agree should be done. Today Sheila Bair proposed her own variation on the theme. At first glance her idea sounds better, but it’s just as bad as the others.

From Alison Vekshin at Bloomberg:

Federal Deposit Insurance Corp. Chairman Sheila Bair, breaking with the Obama administration, said U.S. financial companies should prepay into a fund the government would use to unwind large failed firms.

Congress should set up a Financial Company Resolution Fund and force institutions with more than $10 billion of assets to pay before a firm collapses, Bair said in testimony prepared for a House Financial Services Committee hearing today. Investors in failed companies also should take losses, she said.

As I noted in my column yesterday, Barney Frank’s legislation would have taxpayers front money for systemic bailouts while large financial firms would be on the hook to pay the money back.

Of course that would never happen. Banks would never pay. Look how hard it’s been to get banks to replenish the Deposit Insurance Fund. Anyway, Sheila agrees that ex-post funding is a bad idea.

But pre-funding is an equally terrible idea. If there’s a fund somewhere that’s supposed to protect the system, that will codify TBTF and reinforce moral hazard. Not only will investors know some firms are TBTF, they’ll see there’s a pile of cash to protect them. This would put TBTF firms at an advantage in the marketplace.

Now, some would argue that it would penalize the firms because they’d have to pay capital into the fund. Perhaps in the short-term. But soon enough everyone will be content that the system is “safe,” people will be making money and Congress will tell the regulators to lay off.

This is not just a hypothetical. Look at our experience with the Deposit Insurance Fund. From 1996-2006, FDIC was prevented by statute from collecting insurance premiums. Congress, in its infinite wisdom, had determined the DIF didn’t need any more money because the system was firing on all cylinders.

The S&L crisis–which cost $150 billion to resolve–taught us the moral hazards of government insurance funds for bank creditors. Because their money iss guaranteed, depositors don’t care what kind of risky activities their bank are engaged in. They just go to the bank that offers the highest interest rate.

We’re reminded of this fact by GMAC today, whose subsidiary Ally Bank is able to attract billions in deposits by offering high interest rates. And read the Puget Sound Biz Journal’s article on WaMu. They were so desperate for funding amid a bank run last fall that they started offering 1-yr CDs at 5%.

And think about what’s being insured here. Trading. In derivatives, stocks, bonds, forex, commodities …. all of it with leverage. Trading + leverage = high risk!

Despite the moral hazards of deposit insurance, we insure commercial banks because the functions they provide (managing the payment system, turning savings into loans) are important to society. In the fullness of time, I have my doubts that even this makes sense. But arguments supporting it are at least defensible.

This new scheme that Bair is proposing would insure investment banks, and all the risky trading activities they engage in.

Again, we’re acting to protect the needs of TBTF banks rather than protecting the needs of society. What we should be doing is getting trading activities out of the banks to begin with.

The repeal of Glass Steagall essentially put the Wall Street Bull inside the China Shop we call the commercial banking system. We’re surprised when he trashes the place every few years?

But instead of kicking him to the curb, we’re expending all this effort putting the China in bubble wrap…..which in the long-run is no match for the Bull….

At Buttonwood, Sheila Bair noted that the DIF’s balance, its net worth, is now negative. They have $20 billion+ of cash on hand, but much is accounted for by the fund’s contingent loss reserve, which is to say the money is spoken for based on failures already in the pipeline.

The plan to accelerate assessments on banks is an accounting gimmick that protects their earnings and capital. That said, it’s good news FDIC will be raising more cash, $45 billion is the estimate.

Remember, because of this accounting treatment, the DIF will have more cash, but its balance will continue to be negative for some time. The $45 billion will be accounted for, not as capital, but as deferred revenue, which is the gimmick to protect bank capital.

Important: expect LOTS of sloppy reporting on this point. Most news articles in future will tell you the DIF is negative without noting that cash is on the balance sheet.

#99

• Failed bank: San Joaquin Bank, Bakersfield CA
• Acquiring bank: Citizens Business Bank, Ontario CA
• Vitals: as of Sept 29, assets of $779 million, deposits of $631 million
• DIF damage: $103 million

At the conference, I asked Sheila Bair would she support policies to proactively shrink too-big-to-fail banks?

“No. I don’t know how we would do that.”

She said, for instance, she didn’t think anything like a $500 billion cap on assets would be workable. She said we need to articulate that government won’t be there next time so that the market imposes discipline on banks. Hence, her emphasis on the need for broad resolution authority to resolve the biggest financial institutions.

Another specific policy proposal: limit the claims of secured creditors so that they face losses of up to 20% when a bank fails. Presumably, if they were on the hook for losses, it would be harder for banks to raise debt without having a substantial equity cushion and without acting prudently on the asset side of the balance sheet.

She also repeated her suggestion that there be an insurance fund for the biggest banks, statutorily prohibited from bailing out shareholders. That’s an important last point. The risk of creating a new insurance fund for TBTF banks is that it would REDUCE market discipline, that, done wrong, government would effectively be codifying the implicit guarantee that TBTF banks currently enjoy.

So long as a fund stands behind them, depositors and lenders may not demand the most robust risk management. That’s my concern with proposals to designate certain big banks as systemically important. It might just send a signal to markets that these banks are backstopped, so funding would flow to them at below-market rates, allowing them to grow even larger relative to banks not so-designated.

Why did Fan and Fred attract so much capital? The implicit guarantee…

Another proposal: limiting the amount of short-term secured funding banks are allowed to have. That’s why investment banks were dropping like flies over weekends, because much of their funding was short-term. Their lenders could walk away on short-notice. Basically, they were being hit by the up-market equivalent of a bank run.

Asked if we should reinstitute/update Glass Steagall, Bair said no, that’s probably not possible, but she did say insured deposits are being used in risky ways she doesn’t like. She singled out “prop trading.”

Amen.

Investors are celebrating an incipient “recovery,” but the interventions responsible are sowing the seeds of a more violent contraction down the road. The problem, quite simply, is debt. We’ve accumulated record amounts, yet many economists tell us we need more.

Leading the charge is Paul Krugman. He exhorts us to borrow our way back to prosperity, but he doesn’t acknowledge that his brand of Keynesian economics ignores debt’s consequences. If you look at a chart of America’s total debt burden, he’s leading us over a cliff.

(Click chart to enlarge in new window)

The problem begins with the flawed way Krugman and other economists measure well-being. Primarily, they look at measures of activity, like GDP. These tell us how much people spend, but say nothing about where we get the money.

Every so often, we overextend ourselves, buying too much useless stuff with too much borrowed money. So we cut back, dumping the third family car and swapping the McMansion for a townhome.

But this is problematic for Krugman and other economists. Less spending means falling GDP. It means “recession.”

They ride to the rescue with two blunt instruments — monetary and fiscal policy — that encourage more borrowing and thus more spending. More spending equals “growth” so economists congratulate themselves for engineering “recovery.”

But if recessions never happen, bad businesses and unpayable debts are never washed away. They grow like cancer inside the system.

Since the mid-1980s, we’ve intervened whenever the economy hiccuped, so sectors that should have shrunk sharply — like housing and finance — never did. Feasting on easy credit, these sectors have exploded as a percentage of the economy.

Now, since individuals and corporations refuse to borrow more, the only way to grow spending is for the government to borrow.

According to George Cooper, author of The Origin of Financial Crises, “what is missing from today’s debate is recognition that previous growth rates were artificially supported by an unsustainable credit binge, itself the result of the misapplication of Keynesian policy.”

Cooper counts himself a Keynesian but says Keynesian policy has become “dangerously distorted.”

“We should be using Keynesian stimulus only to arrest the rate of credit contraction not to reverse it. The harsh truth is that our economies desperately need a recession.”

That’s because they desperately need to de-lever. As you can see in the first chart, debt relative to GDP is at record highs.

If we want sustainable growth, spending that drives it must come from savings, not more borrowing. To get there, we must first pay old debts. And that means recession.

Krugman is clearly aware of the consequences of excessive borrowing.

“I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits,” he wrote in 2003, citing a $1.8 trillion 10-year deficit projection from the Congressional Budget Office.

Fast forward six years, total debt has jumped 70 percent relative to GDP and optimistic projections put the 10-year deficit at $9 trillion.

This time, however, Krugman dismisses deficit “hysteria,” arguing that we can grow our way out of debt. “We did it during the Clinton administration,” he told me when he visited Reuters last week.

But we didn’t. While Clinton balanced the federal budget, Americans plowed through their savings. We kept growing because, in the aggregate, we were still accumulating debt.

(Click chart to enlarge in new window)

Krugman has also argued that we can handle larger deficits because we have in the past. After all, public debt peaked at 118 percent in 1945 compared with 65 percent today.

Two problems. First, the argument ignores tens of trillions of unfunded obligations for Medicare and Social Security, debt Krugman loudly lamented in his 2003 column.

It also ignores the higher private debt burden facing us today. According to economist Steve Keen, “Private sector debt accumulated in the 1920s was wiped out by the Depression, so in 1945 the private sector’s debt burden was only 45 percent of GDP. In that situation it was easy to wind down public debt from levels reached to finance WWII.”

Today, private debt is a suffocating 300 percent of GDP, making more public debt that much harder to pay down.

We know how this movie ends. Look at California — or Argentina.

We chortle from afar — “how did their budget get so out of whack?” — yet our own profligacy puts us squarely on that path. Like them, we’ve shown no political will to deal with debt. And so it will deal with us.

But we can print our own currency, you say. If all else fails, the United States can inflate its way out of debt.

Nonsense. If we try, our foreign lenders will cut us off.

As Krugman warned in 2003: “My prediction is that politicians will eventually be tempted to resolve the (fiscal) crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.”

Yet today Krugman is leading the march, arguing that we can borrow indefinitely as long as deflation remains a threat.

Tell that to the Chinese.

What happens when they stop buying our bonds? To Cooper’s point, we’ll need government intervention to cushion the blow of de-leveraging. But there’s a difference between cushioning the blow and reinflating the bubble, which is what we’re doing, wasting trillions propping up housing and banking.

The risk is that we’ll have nothing left when we really need it, when the Great Leveraging becomes the Great De-Leveraging.

MUST READ–Big food vs. big insurance (NYT)“What happens when the health insurance industry realizes that our system of farm subsidies makes junk food cheap, and fresh produce dear, and thus contributes to obesity and Type 2 diabetes? It will promptly get involved in the fight over the farm bill — which is to say, the industry will begin buying seats on those agriculture committees and demanding that the next bill be written with the interests of the public health more firmly in mind.”

Condo owner finds out he’s been living in (and renovating) the wrong unit (kdvr.com)

Greenspan: Gold Rally signals move away from paper currencies (Bloomberg) Interesting that Greenspan is coming back to gold. Once upon a time he was a big fan. And yet he inflated the dollar with aplomb, creating rivers of dollar liquidity that inflated asset prices and put trillions into the hands of foreigners and their central banks. These dollars still represent claims on American production. Over time the result is likely to be higher inflation and/or more American assets falling into the hands of our biggest foreign creditors.

Wells Fargo exec uses house surrendered to bank by Madoff victims (LA Times) Not great PR for Wells…

Flashback: Democrats boo Bush at 2005 State of the Union (RealClearPolitics) It’s funny to me, how Democrats are hyperventilating about Rep. Joe Wilson’s outburst at Obama’s speech. Compare that outburst by a single Republican to the chorus of boos at Bush’s 2005 State of the Union. I don’t see a problem with either outburst, really. I’ve always wondered why decorum is so highly prized at presidential addresses in the first place. The office deserves respect, sure. But not too much. Maybe we should take a page from the Brits playbook … subject our guy to questions.

Controversial sprinter is a hermaphrodite (Guardian, ht ES)

Nine women rescued from fake Big Brother house in Turkey (Guardian)

VIDEO: Priests crack coconuts on devotees’ heads (National Geographic) After the two minute mark, there’s an explanation for where this painful ritual came from…

Volcano erupting from space (gizmodo)

From Carl Richards, as seen on garp.com

“Maybe, just maybe something is wrong with the model. Maybe there is nothing standard at all about risk. Maybe there is nothing normal about returns. Maybe risk is not like a little dial we can control on clients’ portfolios like we tune in a radio…Or maybe, just maybe, reality is wrong.”

This is a snippet from Mr. Richards’ short piece talking about what he’s learned since Lehman collapsed. (That last line is sarcasm, if you didn’t catch that.)

I wonder how many asset managers really think of modern portfolio theory as immutable. Most have to know it’s flawed. I suspect many adhere to it (and other imperfect models) because they have no choice. They have assets to invest and MPT is a convenient guidepost, however imperfect it may be.

As violent as the September thru February period was, at this point, many have moved past it. It was a big downturn, sure, but when the system was rescued, so were the troublesome theories and operating methods that led to the crisis in the first place. The Great Depression was so long and so deep, that folks couldn’t help but take certain lessons to heart … for instance, that debt is dangerous.

For much of Wall St., it’s back to business as usual.

Warren Buffett is back as the nation’s financial conscience, publishing an op-ed in yesterday’s NYT lamenting the dangers of too much monetary and fiscal stimulus. As regular readers of this blog are aware, that’s a message with which I wholeheartedly agree. My problem with Buffett’s piece is that he makes a good argument and then totally undercuts it in his conclusion:

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

This have-your-cake-and-eat-it-too approach is typically what we get from Paul Krugman: Yeah, debt is a problem and has to be dealt with long-term, but in the meantime we should jack up deficit spending in order to boost growth. To paraphrase St. Augustine, make us fiscally and monetarily prudent, just not yet. Ben Bernanke said something of that sort in a speech. He was trying to be funny.

The problem, it seems to me, is that rising GDP and employment—i.e. “recovery”—is not compatible with de-leveraging, which is what Buffett is talking about.

When consumers try to cut debt and boost savings, the economy goes into a deflationary spiral that Keynesians argue must be counteracted with fiscal and monetary stimulus.*

Consumers de-lever, government re-levers.

Private consumption and government spending now drive something like 80% of GDP. It can’t keep rising unless consumers, the government or both continue borrowing huge sums.

The goldilocks economy Buffett describes, in which we can have “recovery” without increasing debt, is a fantasy.

My point is that in order to reduce debt we have to endure some sort of deflationary recession. The alternative is to spend and print perpetually, which Buffett points out is the worse option.

What Buffett should have said? Suck it up folks, we’ve no choice but to learn to live with less.

——

P.s.: I think Buffett actually knows this, but being asset-rich, he’s boxed in. Deflation hammers the value of all non-cash assets, so he has to support monetary/fiscal stimulus in order to preserve his own and his shareholders’ wealth.  Hence the opening of the piece, which lauds the “wisdom, courage and decisiveness” of the Bush and Obama administrations in the face of collapse, and the end of the piece, which says their emergency measures continue to be necessary. He maligns the effects of stimulus, but he’s stuck supporting it.

*The “Paradox of Thrift” this is called, a particularly problematic economic theory used to justify heavy government borrowing.

(send links, pics, vids to optionarmageddon at gmail)

U.S. raids Colonial bank office in Florida, serving “TARP-related” warrants (Reuters)  Cheers for kicking butt and taking names.  As the special inspector general for TARP, Neil Barofsky has broad authority, including subpoena power and the right to carry a handgun.  This profile in the WSJ quotes critics that say he’s got too much Eliot in him, Ness or Spitzer, “over-stepping” his bounds or other such nonsense.  With the vast legal apparatus that rich banksters are able to hide behind, we need a guy who’s not afraid to offend delicate sensibilities.

Hot Waitress Economic Index (NY Mag)

Wall Street profits from trades with Fed (FT)  Makes a great point.  Too bad there aren’t any numbers here. But then the Fed won’t make that possible; it won’t let anyone audit its books.

Boom and Bust will be with us for some time (FT, via Kedrosky)  The former SocGen strategy duo (Montier recently left) take on the adaptive markets hypothesis.  Keeping economists honest!

Cops: Wife, three other women torture husband (Chicago Breaking News)  “Torture” is probably too strong a word.  Then again…

10 years ago, an omen no one saw (NYT)

Trump cuts price on Park Ave. penthouse by 40% (NY Post)  WSJ also had a good page 1 story this morning on the problems at the high end of the housing market.  So much for the top of the market being the last to decline and the first to recover…

Japanese couple turns down free trip to Rome, says would be waste of Italian taxpayers’ money (abc.net.au)

Barney’s illegitimate child? (imgur)  I can’t believe I never noticed the resemblance.

Cosmoplitan (incredimazing)

Another clever music video from Nick Gogerty.  Go to his site to get the quick explanation of “catchment area.”  In a nutshell: “homes need people’s incomes to support their value.”

See also Nick’s Yield Curve Mambo.

My colleague Chris Swann says to beware of housing false dawns. I couldn’t agree more.  While the pace of decline in house prices moderated in April, one has to consider the stupendous monetary stimulus that helped drive that improvement.  With rates about as low as they can go, the only way to drive a sustainable increase in prices is to increase buyers’ income.  With the employment picture continuing to deteriorate, don’t look for rising incomes any time soon.

(Click chart to enlarge in new window)

The chart above plots the month-over-month change in the composite 20 index compared to average 30-year fixed-rate mortgages.

Bulls would point to an improvement in the so-called “second derivative,” a decline in the rate of decline.  From March to April prices dropped only 0.6%, far better than the 2%+ declines each of the prior six months.

Bears would argue that the data showed a similar increase a year ago, and then promptly turned back down.

But prices have fallen 18% since last year, bulls might say.  They can’t fall forever.

The trump card, however, falls to the Bears in my view:  Mortgage rates are 110 basis points lower today than they were just last fall.  That’s a lot of monetary stimulus.

When rates go down, prices go up (all else equal).  A quick present value calculation shows that a $3,000 monthly payment can pay off a $500,000 30-year mortgage priced at 6%.  Drop rates to 5% and that same monthly payment will support a $558,000 mortgage.

Admittedly, this is a simplistic way to look at house prices.  But it serves to show how incredibly sensitive they are to interest rates.

But low interest rates, along with lending structures that allow people to borrow more relative to their income, only offer a temporary sugar high for house prices.  There won’t be a sustainable increase in prices until there’s a sustainable increase in buyers’ income.  And that’s not happening any time soon, not with unemployment speeding towards double-digits.

For more charts analyzing today’s Case-Shiller data, see below.

(more…)

The stock market was down again last week, consumer confidence is at 30 year lows, house prices are declining nationwide for the first time. Is there any good news to report about the economy? Indeed there is: a gallon of gas is approaching $4 per gallon, which I think is just super.

How could I possibly get excited about something that is causing hardship for so many people? Precisely because it is causing hardship for so many people. Hardship, you see, leads to changes in behavior.

(more…)

FT is reporting that banks are pressing their case to have fair-value accounting rules relaxed.

The world’s leading banks have stepped up pressure to relax controversial accounting rules with a new plan aimed at breaking the “downward spiral” of huge writedowns, emergency fundraisings and fire-sales of assets.The proposals on “fair value” accounting by the Institute of International Finance, an alliance of 300-plus companies chaired by Josef Ackermann, Deutsche Bank’s chairman, would enable financial companies to cushion the blow of financial crises by valuing illiquid assets using historical, rather than market, prices.

Of course banks would prefer to carry the value of their illiquid assets at “historical” rather than “market” prices. If they’re allowed to do so, they can carry billions in paper losses without actually writing down any assets.

Kudos to the various “accounting standard-setters” who are resisting this pressure. Allowing banks to carry toxic trash on their balance sheet at values they determine themselves threatens to turn the American and European financial sector into Japan circa 1995. Bank writedowns, and even some failures, may be painful in the short-run. But the long-run health of the economy depends on efficient capital formation. It depends on creative destruction to eliminate economic rot.

This blog is dedicated to more than the deterioration of Fannie and Freddie, I promise. I think the reason I devote so much space to the topic is the sheer size of these two entities and the risk they pose to taxpayers.

Three facts to chew on:

• At $5.3 trillion, the combined debt of Fannie and Freddie is half that of the entire Federal Government
• “Core capital” at the two companies is less than 2% of that combined total of $5.3 trillion….less than $90 billion.
• The companies’ exposure to subprime and Alt A mortgage loans (i.e. the most risky ones in the market), exceeded $700 billion at the end of last year.

A 20% fall in the value of their risky assets alone, would be enough to push them towards bankruptcy, forgetting for the moment that there may be billions of losses yet to take in their “prime” portfolios.

(more…)