Investing Blog

Freddie and Fannie Mae are huge. Together they hold $5 Trillion of US mortgages which equals roughly 50% of the US mortgage market. If these bankers prove to be insolvent, the United States will have a crisis on its hands in the form of 1970-80s style stagflation. To bail out these two banks, the national debt would have to adjust from $10 Trillion to $15 Trillion.

Financing the bailout is nearly impossible without printing more money. Though the Chinese and Japanese have long been buying US treasuries and debts, there is literally not enough money in the world to absorb the holdings of Freddie and Fannie. The only source for the $5 Trillion would be the Federal Reserve and though the Fed doesn’t have $5 Trillion in cash, it does have the power to print $5 Trillion in fresh credit.

Bailing out these banks would be the nail in the coffin for the US dollar. M3 money supply would grow by 50% in one day just to cover the banks. Though there may be some value left in the assets of the banks, the returns would not be seen for years and thus cause massive inflation concerns while the assets bring a return.

Generally when money is borrowed from overseas it is done so that the end effect is deflation. The United States exports dollars which are kept in reserve and out of circulation in trade for goods or services with value. In the short term, the US shows a net gain until the cost of the fresh money is calculated into forex rates.

If these banks need a bailout its going to spark huge problems for the US economy. With any luck, the books of Freddie and Fannie are experiencing an accounting error rather than insolvency. Chances are the companies are showing less in losses than actual, let’s hope for anything but a bailout.