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« Wall Street Has Won: Elizabeth Warren 'Speechless' About Super Galactic Bonuses | Main | Goldman Director Bill George: Top Bankers Are Like Movie Stars And Deserve To Be Paid Accordingly »
Tuesday
Jan052010

Timothy Geithner Meets Vladimir Lenin

By Fund Manager John P. Hussman, Ph.D.

“The best way to destroy the capitalist system is to debauch the currency.”

Vladimir Lenin, leader of the 1917 Russian Revolution

Last week, while Congress and the nation were preoccupied with the holidays, the Treasury made a Christmas eve announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years.

Put simply, in a single, coordinated stroke, the Treasury and the Federal Reserve have encroached on spending powers that are enumerated for the Congress alone. Under the Housing and Economic Recovery Act of 2008 (HERA), the Treasury has no such open-ended authority. Indeed, the applicable portion of the Act explicitly limits the total amount of mortgage principal (not losses, but total principal) as follows:

"LIMITATION ON AGGREGATE INSURANCE AUTHORITY.—The aggregate original principal obligation of all mortgages insured under this section may not exceed $300,000,000,000."

That's $300 billion of original principal. If there is some loophole by which the Treasury's action is legal, it's clear that it was no part of Congressional intent, and certainly not broad public support. Taxpayers are now being obligated by the Treasury and the Fed to make good on a potentially much larger volume of bad mortgage loans, made by reckless lenders, guaranteed by Fannie Mae and Freddie Mac in return for a pittance (called a “G-fee”), and packaged into securities which are now largely owned by the Federal Reserve, which has acquired them through outright purchases (not traditional repurchase agreements).

Is the Treasury's policy a game-changer? No – it simply establishes the government bailout of bad mortgage debt more formally. As I wrote five years ago in Freight Trains and Steep Curves, when the foundations of the recent credit crisis were being laid: “the real question is this: why is anybody willing to hold this low interest rate paper if the borrowers issuing it are so vulnerable to default risk? That's the secret. The borrowers don't actually issue it directly. Instead, much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government . These are held by investors precisely because they piggyback on the good faith and credit of Uncle Sam. On the issuer side, a great many borrowers have linked their debt obligations to short-term interest rates. This is tolerated by the financial system because the debt has been swapped out through financial intermediaries, so investors get to hold relatively safe instruments like bank deposits and Fannie Mae securities. This mountain of debt in the U.S. financial system - tied to short-term interest rates - is ultimately and perhaps somewhat inadvertently backed by the U.S. government.”

What will be a game-changer is if Congress fails to recognize that the Treasury's action is at minimum an evasion, and possibly a usurpation of powers that are enumerated to Congress alone. If Congress does not forcefully defend that prerogative – even if it ultimately ends up voting for exactly the same policy – it will have relinquished the power of fiscal policymaking into the hands of unelected bureaucrats. This is real public money that is being spent to make bad mortgage loans whole. It may not appear to be costly at present, since risk-averse individuals conscious of credit risks, and foreign countries running massive trade surpluses, are still willing to accumulate the Treasury securities being issued, with no apparent impact. But ultimately, those securities will either stand as claims on our future national production, or they will be inflated away. Either the Treasury securities will retain value, so that holders such as China get to use them to acquire our productive assets in the future, while we ultimately tax ourselves in order to pay off that debt, or we must dilute the ability of those Treasuries to claim real goods and services, which is another way of saying we inflate away the debt.

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Reader Comments (5)

I like to see Obanka and his love interest Geithner seated so near to one another, their heads so close together.
It helps me envision slapping them simultaneously, 3-Stooges Style.
Jan 5, 2010 at 9:00 PM | Unregistered CommenterRecoverylessRecovery
RlessR...

It was Timmy's father that was giving Barry's mom the high hard one (a fastball pitch delivered high in or above the strike zone). Barry's momma worked for Peter Geithner. Peter was showing her how to give microloans to the less fortunate.
Jan 5, 2010 at 10:50 PM | Unregistered CommenterGobiasBestFriend
I'd rather crack their skulls together and then tweak Geithner's nose. Moe for President!.
Jan 5, 2010 at 11:40 PM | Unregistered CommenterJames H
This Hussman piece is awesome. I was out of the loop a little bit over Christmas, but this puts all the pieces back together for us. It's amazing how prescient he was about the Bear bailout and the implications for our form of government. That's all. I really enjoyed reading this.
Jan 6, 2010 at 12:27 AM | Unregistered CommenterJames H
thanks james...i hoped the regulars around here would take the time to read it in its entirety...

did you see the latest news...chris dodd will NOT run for re-election...

http://www.politico.com/news/stories/0110/31189.html

the DEMs lose dorgan and dodd in 1 day....might actually help the DEMs because Schiff would have CRUSHED dodd imo...and blumenthal will be a much more formidable and popular candidate...
Jan 6, 2010 at 1:23 AM | Registered CommenterDailyBail

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