Gold News

Capitalism in Retreat

What Fannie & Freddie mean for the Dollar, free trade, and taxation...

HOW SURREAL, writes Dan Denning, editor of the Australian Daily Reckoning.

   Less than ten weeks to go in the most entertaining US presidential election campaign in recent decades. Yet right here in the United States of America, capitalism is reeling.

It's under attack by a bunch of socialist bankers and the politicians whom they've purchased to represent their interests (and are themselves hoping for a nice up tick in the stock market before voters head to the polls in November).

You'll know the story all too well by now. Over the weekend the US Treasury Department placed America's two largest housing lenders – the government-sponsored enterprises of Fannie Mae and Freddie Mac – into conservatorship. Treasury will pump about $1 billion each into each company and get preferred equity in exchange. The government also gets warrants that would give it nearly 80% ownership of both firms. It will probably take at least another $200 billion in new money to keep them solvent.

It's already clear, however, that US taxpayers have 100% of the risk. Fannie and Freddie were too big to fail, apparently. The question now is whether this short-term nationalization will lead to the failure of any other large US the Dollar itself or US Treasury bonds. More on that in a moment.

For its part, the stock market (the global one) absolutely loved the deal. After half a trillion dollars in losses by global lenders, traders love the idea that the worst might be over. Most financials rallied. Even the US Dollar is stronger, which seems a bit strange considering that the US government just added $5.3 trillion in liabilities to its balance sheet.

But here is the theme resounding on the pages of today's papers worldwide: the US is ahead of the curve! The United States has had its slower growth, weaker currency, massive housing meltdown, and lived to tell the tale. So now, with Fannie and Freddie taken to Uncle Sam's bosom, America is ahead in the global game.

That's the theme anyway, and it's probably true with respect to a country like Britain, whose currency continues to plummet and whose house prices have barely started. Yet you don't get the feeling that America's fiscal position was substantially improved by this weekend's action. The responsibility for the losses was simply transferred from a pseudo-public balance sheet to a very public balance sheet.

How is that good for the Dollar in the long run?

In the meantime, the other losers this weekend are those financial institutions who owned preferred equity in the GSEs. The common shareholders never had any rights. (The most recent buyers, mostly hedge funds, had no common sense either.) But according to the Federal Deposit Insurance Corporation (FDIC), "while many institutions hold common or preferred shares of these two government-sponsored enterprises, a limited number of smaller institutions have holdings that are significant compared to their capital."

These smaller lenders are, ahem, screwed. The government intends to work with them on "capital restoration plans". But if you thought this event signaled the end of the losses, think again. There will be more bank failures, and they will happen soon.

What about bondholders in China and Japan? They'll be alright. We don't know exactly how it will work. But somehow we reckon those GSE bonds will end up on the Federal Reserve's balance sheet, in exchange for fresh new US Treasauries (issued by the Treasury Department). In other words, we reckon the GSE bonds will be monetized.

Exactly how is THIS good for the Dollar? Well, you figure that one out. We can't.

But we're not going to stand in the way of a big relief rally. And while we may not have finanicials to kick around anymore, we'll always have energy as a secular investment theme. It would be hard to see the Fannie and Freddie nationalization as anything other than a massive official back-pedal from the free market. So maybe we are entering a new era of less free trade, higher taxes, and more nationalizations.

The government backlash against globalization could last for awhile, making energy resources – and perhaps precious metals – an urgent purchase for national governments. Capitalism and free trade are in retreat.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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