Capitalism model

This week’s turmoil in the US Financial industry, Fannie Mae (FNM) and Freddie Mac (FRE) included, has thrown new light on the kind of capitalism that is being followed. It makes me wonder where the world, and Uncle Sam in particular, are headed towards, economically speaking. The collapse of Indy Mac, a US Bank, is symptomatic of the malaise that has been affecting the US Financial markets, and is an ideal fodder for the socialistic turkeys.

For those amongst us who do not know them, FNM stands for The Federal National Mortgage Association (FNMA) or Fannie Mae in short, and FRE stands for Federal Home Loan Mortgage Corporation ("FHLMC") or Freddie Mac in short.

Both of them are GSE or Govt. sponsored enterprises. Along with other GSEs, they buy mortgages on the secondary market (Banks and Housing companies like Countrywide Finance), pool them, and sell them as mortgage-backed securities to investors on the open market. This secondary mortgage market increases the supply of money available for mortgages lending, and increases the money available for new home purchases.

These companies were created in the 70s, and were meant to be stand-alone commercial. Over the years, these companies have become the backbone of the American housing dream, accumulating about $5.5 trillion worth of housing debt between them. That is, roughly about 40% of the $13.7 trillion GDP of the US in 2007 !!!

Due to the housing market meltdown, the mortgages they had bought, especially the subprime ones, have cllapsed in value. They now need to raise capital, to put themselves afloat, prompting the US govt to come out with “bold measures” to prop them up, over the weekend. Reason? Treasury Secretary Paulson very well knows that people’s hard earned 401K money is at stake, and any possible collapse of these “icons” could lead to a quick implosion and seizure of the great American engine – Financial markets. The results could well be cataclysmic, perhaps even worse than the Great Depression.

Fair enough, one would say? Come to think of it…two commercial orgs. were created back in the 70s with the intent of managing housing mortgages and providing guarantees on housing mortgages( much like Lloyds of London… a sort of reinsurance, to put it crudely) They were expressly meant to stand on their own feet. One of the hall-marks of capitalism is that companies are allowed to fail if the business model is not sustainable. Only in Socialist economies does one find government intervention… so then, in this case, whatever happened to “free market economy”? After all, everyone was lauding the great American innovations and the ever “novel and innovative” financial products that these companies churned out all these years. Something that kept the great American juggernaut moving all these years. When things were going up, the corporations were allowed to take the profits and distribute to “shareholders” and pay fancy CEO packages to run them.

Why then when things turn sour, the tax-payer is expected to pitch in and help out? Remember, there are only 3 ways that the likes of FNM or FRE can get out of the hole they are in:

Govt opens the “discount window” of credit … tax payers money being used up here.
Govt steps in with “equity participation” … again tax payer’s money
Govt buys out the private players by paying them cash, takes over the companies’ assets and liabilities and runs them on it’s own… this is either with tax payers money or simply by printing more $$$$$ !


In other words, the US Govt all along let these “financial wizards” come up with fancy products, to which credit rating agencies like S&P and Moody’s coolly looked the other way. Banking companies continued to provide loans based on inflated market values of properties, and FNM and FRE backed them up. Seemed fine, as things were Northbound. But when things turned sour, the Govt decides to use taxpayer money to bail out the wrongdoings of these corporates. So much so, that it is wiedly expected that shareholders will now demand that the Govt take over the Operations of FNM and FRE and run them…

The most amusing part is- taking over and running ( for a different reason, though) is what Hugo Chavez did exactly, last year to the big oil firms in Venezuela… so did the Russians… so did Indira Gandhi in the 70s in India, to the Banks… in “Socialist” parlance , this is called Nationalisation !!! Something that was frowned upon by Uncle Sam… “ goes against the very grain of free market economy”… “ companies should be allowed to fail”… etc etc…. the Fed and the Treasury are now made to eat humble dollars ( thanks to food prices, the humble pie remains humble no more!!)

To me, America is on the throes of Capitalist cross-roads. The signs on all four directions, unfortunately, are, rather ominously, pointing to anything but Financial Nirvana!!! Bertie would be tempted to quip, " Ah, Jeeves! Nowhere to hide would be right phrase".