Paddling Around In Billions of Dollars of Sub-Prime Mortgages
You might remember this analogy written in this column last March 18th.
“Imagine you are in a boat in the Atlantic Ocean. Maybe you have a few friends with you. The boat springs a leak late last year as you are rowing into shore. You and all your mates start bailing water, trying to keep the boat a float as you look toward the shore. Miraculously, it works but the current changes and you are blown away from shore. Leaks spring up again and you keep bailing. You get closer to shore but then the current changes again. Around you are other boats with the same problems. There are even bigger boats that are leaking as they lurch toward shore. The current changes again. More leaks are patched. Everybody is still alive, but you’re growing tired. Patching those leaks seems to be a never-ending process. You all hope you have the stamina to keep it up. As of this moment you see shore, but still you just can’t get there. (At Issue March 18, 2008)
That’s how I described the American sub prime mortgage crisis with large American banks failing like Bear Stearns. The US Federal Reserve kept cutting interest rates in the hope people might get some of that debt paid off. Everybody kept paddling furiously. As of yesterday, they were still out there paddling like they were modern day courier de bois. They weren’t getting anywhere, but on Monday a miracle happened. Everybody can stop paddling, get out of your boat and walk to shore. IT’S A MIRACLE! The Atlantic Ocean has been sucked dry!
If you’re still reading you might have an idea what I’m talking about. With Monday’s announcement of the US government’s takeover of Fannie May and Freddie Mac, the largest mortgage holders in the US with more than two thirds of US home loans, the worst vestiges of the sub-prime mortgage crisis is over. Essentially the US government drained the ocean. Now, everybody can at least run up on shore. Holders of the bad debt, which totaled about $200 billion dollars, have got a reprieve. It’s like Independence Day.
Huge holders of this debt were Japan and China, which held lots of Freddie Mac and Fannie May bonds. In fact throughout the whole global financial system the American mortgage debt has threatened to submerge the world financial system. With the world economy currently hitting the skid that is about the last thing we needed. American interest rates will still have to move down. However, at least for the moment, somebody has an answer. The American taxpayer is getting the bill.
Essentially the US government has chosen to inject up to $10 billion in each company for any quarter where they would be insolvent. The US government is also receiving $1 billion dollars in preferred shares and investing a further $5 billion in securities backed by some of these mortgages. It’s a bit “nuts” except for one fact. That is the US government, which is backing these companies up and they’ve got the most money in the world. So at the end of the day, it’s the solution everyone has been waiting for. Barack Obama and John McCain beware: you guys are going to get the bill.
Stock markets reacted by exploding. In New York, the Dow Jones was up over 289 points on the news. In Toronto the market went up too, but then settled back losing 181 points based on slackening demand for commodities like oil and potash because of a weaker global economy. Of course the two are related. The weakening global economy is partly because of this roving mortgage debt floating around the world taking everybody’s money. Carrying un-payable debt is an economic killer. That’s why the American government’s move to save the day couldn’t have come at a better time.
Critics would argue I’m being a bit trite with that explanation. The debt is essentially all still there, but it finally has a home in the form of the US taxpayers. At the end of the day, global debt will be paid. Essentially the US is bailing out the world economy, which got a bit drunk on a shaky American policy, which produced all of this “serviceable debt.”
You can bet there is a little bit of relief in some Canadian banking circles. Our outrageously profitable Canadian banks surely got in on the American sub price fire sale. Could you imagine the outrage if more of that was written off during the newly minted election campaign? I can just hear Jack Layton now.
For the individual American mortgage holders reaching shore after all that paddling must seem like heaven. However, many of them will simply throw the keys in the sand. They still have to pay their mortgages, but at the same time you can’t milk stone. The US government guaranteed them nothing. However the government did guarantee the providers of the deficit financing. Nevertheless, the effect on the US housing market going forward may not change. It all might end up being a reprieve at the eleventh hour.
We’ll see. However, one thing the bail out did was make this more of an American problem and less our problem. God Bless George W. Bush. Maybe, just maybe this will be his final gift to our world.