Sunday, 7 September 2008

$1 trillion bail-out; Badger cheers!

Robert Peston's reaction to the news that the US government is to bail out mortgage companies Fannie Mae and Freddie Mac by saying that our little problems with Northern Rock pale by comparison.

For all the detail and comment you could want on this story see Barry's blog here.

Sadly the NR comparison is not quite true. NR never had oblique Government guarantees, NR has a worse looking portfolio of loans than either of these two companies. The US estimate is that if 10% of mortgages for bad then the US taxpayer could be $100 billion in the hole. However, we have already 'invested' £3 billion in NR and if 10% of the £40 billion loans go bad then we are on the hook for £7 billion loss. Our economy is 10x smaller than the US and we also have a current exchange rate of $1.75 to the pound.

Therefore US losses estimated at $100 billion / 10 (economic capacity) x exchange rate 1.75 = £5.7 billion.

Northern Rock losses estimated at £7 billion.

Great performance by our Chancellor eh?

My two cents: the markets may rise but this bail out surely will cause foreign investors to think twice about the US. The Dollar rally may continue for a bit, but it seems that the US has decided to inflate its way out of the credit crunch for sure this time.


Wolfie said...

...the US has decided to inflate its way out of the credit crunch for sure this time.

What I expected right from the start, which means that the dollar rally is short-term and the winner will be about a race to the bottom.

Anonymous said...


rwendland said...

AP says "The companies ... own or guarantee about $5 trillion in home loans, about half the nation's total", and Wikipedia concurs adding "because [of] the subprime mortgage crisis ... they are responsible for more than 80% of new mortgages being made in 2008".

So how does 10% of this only come to $100 billion?

CityUnslicker said...

RWENDLAND - Only $1 trillion sub-prime or one grade above.

rwendland said...

Northern Rock loan book is £84.4 billion. Why do you think £40 billion (47%) might go bad compared to 20% for Fannie and Freddie?

While the govt has lent £3 billion, Northern Rock has £3.5 billion at the Bank of England for liquidity. Would this really be lost on top of any write-off on the loan book? Consolidated equity stands at £2 billion, which presumably can stand a few years of operating losses.

Looking at the 2008H1 accounts the loans split is:

7% Buy to let
26% Together
67% Standard

If we assume 25% of the non-standard loans and 10% of the Standard loans go wrong, and in each case 25% of the loan cannot be recovered, I make the write-off £3.1 billion:

(((0.33 * 0.25 * .25) + (0.67 * 0.1 * .25)) * 84.4 = 3.148

Arrears are currently less than the Council of Mortgage Lenders average.

But it does seem to have £3.5 billion of "Treasury investments" graded lower than AA, which is probably a worry, though impairment charges have been made against this risk.

Anonymous said...

China has made it clear that inflate-out is better than wipe-out as far as its IUS holdings are concerned.

CityUnslicker said...

RWENDLAND - Can't fault most of your logic. Except the Together loans are the product which is all 100%+ mortgages, the buy-too-let is a terrible portfolio they could not sell when they tried.

If all this goes wrong, plus say a quarter of the standard you get to 47%.

That is not entirely unreasonable.

Also I forgot to add in that there are no guarantees to depositors at fannie and freddie; this guarantee costs money too which is why the auditors put it on the Government books.

rwendland said...

While Fannie and Freddie debts might not be guaranteed WSJ says "In recent weeks, Treasury officials have been reaching out to foreign central banks and other overseas buyers of securities or debt sold by the two companies, to reassure them of the creditworthiness of these instruments." Sounds as good as a guarantee to oversea investors.

With Fannie and Freddie backing about 75% of 2008 mortgages, this seems to me to be much more of a committment than Northern Rock which is being carefully run down.

Stock market certainly seems mightily relieved the big banks won't lose much on this.

Anonymous said...

Since the US, and probably every other western democracy, has public sector debts that will have to be reneged on by inflation, perhaps the powers that be reckon that they might as well start the inflation now and kill two birds with one stone.

Anonymous said...

"The FED is bailing us all out!"

Dow jumps up.


"Oh, hold on, this means the US economy is really in the shit"

Dow slumps back.

CityUnslicker said...

Dearime has it in one

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