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In the latest example of financial market madness, the recent
government “bailout” of Freddie Mac and Fannie Mae has perversely
resulted in a sharp rise in the value of the U.S. dollar. If the markets were
functioning rationally, the transference of staggering new liabilities to the
U.S. Treasury would have been immediately seen as catastrophic for the
dollar. Instead the markets have ignored the obviously negative long-term
implications and have remained fixated on the more immediate effects. However,
rather than solving the problems, the government’s actions merely
confirm my worst fears, and increase the chances for a hyper-inflationary
outcome.
By transforming $5.5 trillion of suspect mortgage-backed securities into
seemingly bullet-proof Treasury bonds, the move has sparked a relief rally in
the dollar as foreign investors no longer have to worry about defaults or markdowns. In fact, to holders of Fannie
and Freddie debt, it no longer matters what happens to the housing market. Home
prices can drop another 50%, every single homeowner can default on their mortgage, and bond holders will not
lose one dime. This has emboldened foreign investors, and temporarily
increased demand for both dollars and Freddie and Fannie debt.
Had the government done the right thing and not guaranteed Freddie and Fannie
debt, I believe we would now be experiencing an outright financial crisis. The
dollar would be falling sharply along with real estate prices, gold would be
soaring and the recession would be deepening. However, by nationalizing
Freddie and Fannie, the government has merely delayed the crisis. The
borrowed time will cost us dearly, as the day of reckoning will now likely
involve much steeper losses for our currency.
The Freddie and Fannie takeover does nothing to address the underlying
problems that forced the companies into bankruptcy in the first place. All of
the bad mortgage debt still exists. In fact, based on this bailout, there
will be trillions more in bad mortgages insured over the next few years. The
only thing that has changed is how the losses will be distributed. Instead of
falling solely on bond holders, who had chosen to invest in mortgage debt,
they will now be dispersed among U.S. taxpayers and all holders of
U.S. dollars, who made no such choices.
Over the next year or two, my prediction is that several trillion dollars of
existing mortgages, not currently insured by Freddie or Fannie, will be
transferred to the pile. Going forward the vast majority of new mortgages
made to Americans will be bought by Fannie or Freddie. Therefore in a few
short years the $5.5 trillion of initially transferred liabilities could grow
to more than $10 trillion of new obligations for the U.S. Treasury.
The defenders of the bailout claim that Fannie and Freddie debt does not
represent true obligations because
they are fully collateralized by homes. But anyone with a casual interest in
the current real estate market knows that homes are now only worth a fraction
of outstanding mortgage debt. And that fraction gets smaller every day. My
guess is that $10 trillion of federally insured mortgages could result in $2
trillion of losses, which amounts to more than $25,000 per American family.
Also, there is no reason to believe that the bailout merry-go-round will end
with Fannie and Freddie. Faltering investment bank Lehman Bros. is now
positioned to receive the kind of Federal backstop that smoothed the purchase
of Bear Stearns back in March. Bailouts of automotive
and airline companies can’t be long in coming. Once the market
perceives a Federal magic wand, it becomes politically impossible to stop
waving it.
In addition to adding new sources of debt in the form of mortgage backed
securities, the government is also piling on debt the old fashioned
way…through budget deficits. Recent projections put the 2008 deficit at
$410 billion, not counting the Iraq war or any costs related to
financial bailouts. It is my guess that the annual
Federal budget deficit will soon approach, and then exceed, $1 trillion, and
that the national debt, including actual bonds and guaranteed mortgages, will
soon exceed $20 trillion. When these untenable obligations force Treasury and
agency investors to shift focus from default
risk to inflation risk, a mass exodus from both Treasuries and mortgage-backed
securities (now Treasuries in disguise) will ensue. The stampede will trample
the dollar.
When the dust settles, the Federal government will be left with staggering
liabilities that will be impossible to repay with legitimate means (taxation
or borrowing). To make good, they must rely on the printing press to create
money out of thin air. The rapid expansion in money supply will push the
dollar down mercilessly.
Right now every asset on the planet is being sold except the U.S. dollar. To
me this rally looks like the last gasp of a dying currency. Just like a toy
rocket ship, once the dollar runs out of fuel it will crash back down to
Earth.
Peter D. Schiff
President/Chief
Global Strategist
Euro Pacific
Capital, Inc.
20271 Acacia Street, #200 Newport
Beach, CA 92660
Toll-free:
888-377-3722 / Direct: 203-972-9300 Fax: 949-863-7100
www.europac.net
pschiff@europac.net
For a
more in depth analysis of the tenuous position of the American economy, the
housing and mortgage markets, and U.S. dollar denominated investments, read
my new book "Crash Proof: How to Profit from the Coming Economic
Collapse." Click here to order a copy today.
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