18 July 2008

Fannie and Freddie sneeze, the world catches a cold

When United States Federal Reserve Chairman Ben Bernanke gave the US Congress a bleak assessment about the state of the country’s economy on Tuesday, he blamed the housing markets, high energy prices and tight credit conditions for a slowing of growth.

Bernanke’s statement came just two days after the Federal Reserve – which is the central bank in the United States - and the US Treasury Department came to the rescue of mortgage giants Fannie Mae and Freddie Mac.

That move marks the latest development in a global financial crisis that was triggered by falls in the US housing market earlier this year.

The US had initially looked to the Fannie Mae and Freddie Mac, two ‘government sponsored’ companies, to sure up the country’s mortgage market when the initial crisis hit.

Now the rescuers – which, between them, hold or guarantee more than $5 trillion dollars in mortgages - have had to be rescued with emergency loans from the Federal Reserve.
In response shares on Wall Street, the US stock market, slumped.

But why does it matter what happens in the US mortgage market? And what was the subprime mortgage crisis, of which this Fanny Mae and Freddy Mac bailout is a part?

As Jim Stanford pointed out in the last Red Pepper sub-prime mortgages were, in essence, cheap loans issued to home purchasers in the United States –offered at low rates to lure buyers into the market. When the rates started rising, the loans were increasingly defaulted – and lenders, realising their investments were liable, started to lose confidence in the market. That loss of trust then had knock on effects in other parts of the financial system, triggering a financial crisis that has seen the US tumble towards recession.

But the bursting of the housing bubble was only one symptom of a much wider financial crisis that is besetting the US economy. With the liberalisation of global economies in recent years, the old economic adage that ‘when the US sneezes the world catches a cold’ still has a ring of truth.

Like most crises, this one was avoidable – but the signs were not recognised by leading bankers and economists.

Bernanke himself attributed rising US housing prices to ‘strong economic fundamentals’ in 2005 – blind to the role of speculative activity in this sector.

The US housing boom was also fuelled by a lack of regulation, with the debt burden for US mortgages parcelled up and resold so that investors didn’t know what they were buying.

This pattern of speculation was itself underpinned by a disconnection between the real and financial economies. In essence, with the ‘real economy’ faultering, investors shifted their money to financial assets from which they could generate greater profits. But with stock markets spiralling out of control – failing to take account of the real value of their assets – it was inevitable that this ‘bubble’ would eventually burst.

The results have so far fallen hardest on homeowners in US, rather than on the corporations which speculated in continued growth. And these same investors have shifted assets back to the real economy – one of the key reasons why food and oil prices have been on the rise this year.

Nor is it a surprise that Chinese capital is the main foreign investment behind Fanny Mae and Freddy Mac.

As Walden Bello points out in an excellent article on chain-gang economics, China’s economic growth has largely depended on the ability of US consumers to continue their debt-financed spending spree to absorb much of the output of China’s production - a process backed up by massive Chinese lending to the US Treasury and US firms.

The result has been an unsustainable cycle of Chinese production and US consumption. And while it could help the Chinese, and the whole globe, to de-couple their economy from the US – there are not yet signs that this is happening.

1 comment:

mizpah said...

Interesting article. Got some useful info and suggestions. Maybe I will link to it on one of my pages(themetitle: financial crisis).
Maybe also on other pages like www.mizpah.tv