Laissez faire? Not so much...

CJR's the Audit spotlights another great article over at the NYT:

Freddie Mac, one of the nation’s largest buyers of home loans, announced a fresh wave of bad news Wednesday, disclosing losses that were smaller than expected only because of accounting tactics that minimized the effects of bad loans.

“It’s clear we have not yet hit bottom in the housing market,” Richard Syron, Freddie Mac’s chief executive, told analysts.

Yet investors cheered the results anyway, and pushed the company’s shares up by more than 9 percent, to close at $27.25.

CJR picks out a home run quote:

“Both [Freddie Mac and Fannie Mae] are clearly going to be insolvent by the end of the year, but everyone knows that Congress will do anything to keep them afloat, because if Fannie and Freddie go under, the entire global financial system will melt down,” said Christopher Whalen, a founder of Institutional Risk Analytics, an independent research firm. “These companies’ earnings don’t matter. Their accounting hardly matters. People buy the stock because they believe the federal government will bail them both out if things get really bad.”

Why do you care?

What Does Freddy Mac Do? (via Slate)

The company is a key player in the secondary mortgage market, which means it purchases mortgages from banks. Freddie Mac then bundles together several thousand such mortgages into a tradable security and sells the package to an institutional investor.

Say you just obtained a $200,000 mortgage with a fixed rate of 5 percent. There's about a one in six chance that your bank will turn around and sell that mortgage to Freddie Mac, which in turn will package it with thousands of other mortgages with similar rates. That collection, which may be valued at $500 million or more, is converted into a bondlike security and sold to large investors who prefer relatively safe, steady assets.

[snip]

The idea is that banks will use the money they obtain from selling mortgages to fund additional mortgages; the system has increased the nation's home-ownership rate. Also, the hope is that banks will feel more comfortable offering mortgages for homes in low-income areas, since they know they can turn right around and sell the mortgage to Freddie Mac. (Freddie Mac does not purchase mortgages over $322,700 in value.)

What Does Fannie Mae Do? (via Motley Fool) Sorta like a chop shop. But legal.

It works this way. Let's say that you get a mortgage on your new home from Wells Fargo Bank (NYSE: WFC). Wells Fargo, like any bank, has limitations on how much money it can lend as a function of its asset base. If your loan sits on Wells Fargo's books, it constricts how much the bank can loan. But if Wells Fargo sells the rights to Fannie Mae, it turns that loan back into cash, which it can then go out and loan again. You keep making your loan payments to Wells Fargo, and it passes these funds on to Fannie Mae. Fannie Mae makes money because it can borrow funds at a lower interest rate than you can. So instead of a single loan tying up Wells Fargo's capital, it can turn around and make multiple loans all from the same original capital base. This, the theory goes, increases banks' willingness to loan in good times and in bad.

[snip]

Fannie Mae provides a guarantee to these investors that they will receive timely principal and interest payments, no matter what happens with the underlying mortgages. If there are large numbers of defaults, Fannie Mae will have to make the investors whole. If there is a massive crash and defaults overwhelm Fannie Mae, it has an ace in the whole: your tax dollars. Even though the company's debt offerings clearly state otherwise, the financial markets believe that Fannie Mae's status as a government-sponsored enterprise implies that the government will provide full faith and credit for Fannie's debt. It is for this reason that Fannie Mae maintains a AAA credit rating, even though at a 78:1 debt-to-equity ratio it is levered many times what is allowed international banks. (Debt is defined as mortgages on its books plus the value of its guarantees.)

Remember those (formerly AAA-rated) CDOs that were eating Merril Lynch alive? Those are the kind of products that Fannie Mae and Freddy Mac sell.

While I'm confident that there are many flavors of these types of investments - any bundle of mortgages is going to have the same Achilles heel: a nationwide drop in real estate prices.

Bear Stearns was bailed out after getting hit hard by Mortgage Backed Securities. Looks like Fannie Mae and Freddy Mac are going the same route - and with Wall Street banking on the bailout, you have to believe the Fed has no choice.

I'm no fan of the economy going in the tank to preserve the purity of laissez faire - but once again: if the consequence of bad investing is getting billions of government dollars, what the hell is the incentive to invest wisely?

Yet another backdoor handout for Wall Street.