A Financial Perfect Storm
A disaster could be imminent!
by James Buchanan
We could be heading for a financial “Perfect Storm.” The Dow Jones kept plunging through new lows during the last few weeks as investor confidence waned. The Dow even dipped below 11,000 on Friday. The subprime crisis keeps claiming bigger and bigger victims. The financial giants Freddie Mac and Fannie Mae who handle 40 percent of all mortgage loans in the US were teetering on the edge of collapse last week. The second largest bank failure in US history (Indymac) just happened last week. Add to all this, the soaring price of oil, which is cutting more and more into consumer spending, which accounts for two-thirds of the US economy.
One news article notes “Troubled mortgage giant Freddie Mac is aiming to sell off three billion dollars in securities on Monday following last week’s meltdown, in a potentially decisive move to heal shattered investor confidence… The two government-chartered, shareholder-owned giants (Freddie Mac and Fannie Mae) underpin some five trillion dollars in home loans, and the meltdown in shares last week raised fears of a government bailout, or a possible worsening of the credit crunch. In highly volatile trade Friday, shares plunged some 50 percent for both firms before a partial recovery. Freddie Mac ended with a loss of three percent and Fannie Mae was down 22 percent, but both have lost around 75 percent since the start of the year… Freddie Mac has a loan portfolio of 1.5 trillion dollars and Fannie Mae’s is over 700 billion. Together they own or guarantee some 5.2 trillion dollars in loans, or about 40 percent of the total value of home loans in the United States. The two firms, which have no explicit government backing despite their government charter, provide liquidity to the housing market by buying mortgages and repackaging them into securities sold to investors. As such they play a key role in the housing system.”
There’s one little problem with the financial collapse of companies that own or guarantee $5.2 TRILLION in loans; it may not be possible to do anything about it. They’re just too big to help.
Not to be confused with “Freddy Mac,” a bank in California named “Indymac” has failed. An article from Fox News reports “Federal regulators said the failure of IndyMac Bank makes it the second biggest financial institution to close in U.S. history. The thrift’s assets have been seized and transferred to the Federal Deposit Insurance Corp. As of March 31, IndyMac had assets of $32 billion. The plan is to reopen it Monday as IndyMac Federal Bank. The head of the Office of Thrift Supervision said IndyMac had “a liquidity crisis.” It was squeezed by tighter credit, tumbling home prices, and rising foreclosures. Regulators said IndyMac customers with funds in the bank are limited to taking out money by ATMs over the weekend, debit card transactions, or checks. Other bank services, such as online banking and phone banking, are scheduled to be available Monday.”
Why does the subprime mortgage crisis continue to get worse? Millions of people are beginning to default on home loans typically ranging from $400,000 to $700,000. Let’s say Joe Flake got a loan for $600,000 with no money down. One year after he started buying his home, he discovers the value of his house has plunged to $400,000. Is Joe Flake going to continue to make payments on a house that just lost two hundred thousand in value? No. Millions of “Joe Flakes” are predictably walking away from massive debt and declaring bankruptcy. For every “Joe Flake” the bank loses about $200,000 as it sells the house for market value. One million of these defaults would equal $200 billion in losses to the banks and mortgage lenders.
And the mortgage crisis is not just limited to people who choose to walk away from their loans. There are plenty of marginal people, who should never have gotten loans. Many people were talked into loans with a low “teaser rate” by unethical real estate agents. As the rate rose, these lenders simply could not make the payments. Add to these people, large numbers of Americans, whose good-paying jobs were outsourced to India or Pakistan. Many yuppies thought that they were “indispensable” to their companies, but our modern Robber Baron Capitalists would sell their own mothers to make a few dollars more.
One additional ominous sign of a looming disaster is a financial panic in the Tel Aviv Market on Sunday. One news article reports “Investors, frightened by the rapidly deteriorating financial situation in the United States, dumped stocks Sunday and drove down indices two to four percent… Financial observers fear that the market may drop even further if the situation in the United States continues to worsen. Several banks have been declared insolvent, and there is growing concern of a domino effect on the entire economy, with serious repercussions on world markets.”