Bigger Role for Fannie and Freddie Could End US AAA Rating

The US has had a free lunch for so long, thanks to the willingness of kindly savings rich foreigners to buy our Treasuries, that the realization that there are limits to what we can have, both individually and as a nation, is hard for many to accept. We managed to have guns and butter for a short while by ballooning our debt to GDP ratio. But now that we are trying to keep the good times going, or more accurately, keep the bad times from being too bad, America is learning the hard way that it is going to have to make choices and tradeoffs. Given the divisiveness of our politics, this will be an ugly process.

The latest: bit of reality rearing its ugly head: Fannie and Freddie have the potential to cost the US its AAA. From the Wall Street Journal:

So-called GSEs enjoy implicit government guarantees and could cause the U.S. to lose its sterling triple-A rating if the government were forced to come to their rescue, Standard & Poor’s said in a report Monday….

The demise of Bear Stearns Cos. and the Federal Reserve’s efforts to alleviate strains at broker dealers has captured the attention of market participants who feared the financial system itself might seize up last month.

While this credit crunch has hurt financial markets, S&P notes that it hasn’t threatened the standing of the nation’s credit quality upon which U.S. Treasurys and debt priced off this government debt depend. But should a protracted recession cause Fannie and Freddie to buckle, the U.S. rating would be in danger.

The cost to the U.S. government in such a scenario would be as much as 10% of gross domestic product. The maximum potential cost of aiding the broker dealers during a prolonged economic downturn would be below 3%, S&P analysts found. The Federal Reserve’s bailout of Bear Stearns and its extension of credit facilities to brokers so far costs less than 1% of GDP.

Freddie and Fannie’s exposure to the housing market heightens the risk of future losses should borrowers run into trouble as home prices decline. That the two companies are guaranteeing larger loans as part of the government’s efforts to shore up the housing market adds to this risk.S&P says, “These potential risks are not a prediction, but a risk worth monitoring.”

It was only in January that Moody’s warned that the US might lose its AAA rating within the next ten years. The S&P note simply provides a specific scenario.

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  1. Francois

    “Given the divisiveness of our politics, this will be an ugly process.”

    I would venture to compare our politics to the politics in academia. Confy, with a full belly and secure future, our estimated professors can’t find anything better than to bitterly argue and fight with venom about their respective pet theories.

    I’m not so sure it’d be that way if they had to focus on keeping their job and making sure they’ll effectively have a future.

    IOW, our politics would have to get real in times of great pain. The reality-based crowd would once again, rule the land.

    Now, I’d rather not speculate about the state of the land when they’d get there.

  2. Yves Smith

    If we have a depression or something not that far off, then I agree, there will be greater unity because the pain will be widely shared. But if we have a mere bad recession (1973-74ish, or 1980-81ish, but longer lived with a slower recovery), you’ll see more variance in the degree of suffering. You’ll also see more disagreement about who is deserving of help and why, and there will be lots of arguments that boil down to equity versus efficiency.

  3. Anonymous

    Well, Moody’s did say that, but it was a sop to the ideologues who want to cut SocialSecurityAndMedicare.

  4. Yves Smith

    We addressed that when the story ran:

    Oof, if this isn’t politically influenced, I don’t know what is. Moody’s says the US risks a downgrade on its debt rating unless it does something about its “social security and healthcare” spending.

    First, everyone who has looked at the data says Social Security is not the problem. And even if it gets worse, some very minor fixes (raising the ceiling on payroll tax liability) will take care of it. The big problem is Medicare, and that in turn results not from demographic change, but from out of control health care costs. In other words, the answer is health care reform, not cutting entitlements. But you’d believe the reverse if you read Moody’s.

    And why does the report not mention the fiscal sinkhole called Iraq?

  5. a

    “If we have a depression or something not that far off, then I agree, there will be greater unity because the pain will be widely shared.”

    What about the Okies in California or the GM strike? Not much unity there.

  6. Thomas

    I’m a bit confused about the use of the word “cost” in the third-from-last paragraph

    In the specific example of Bear Stearns and the brokers (“so far costs less than 1% of GDP”) haven’t the credit facilities merely been extended, and it’s not cost anything, unless we actually get default, which hasn’t actually happened yet?

    Semantics maybe, but I rather feel it’s an important point.

  7. MikeInOregon

    I assumed financing govt. costs 1% now because there is a rush to quality. If the US loses its AAA rating the author throws out an optimistic 10% financing cost.

    It seems to me that once confidence is lost, the currency goes to hell and pretty quickly financiers realize the interest rate would be inconsequential. That is, 10% just wouldn’t do it.

  8. Richard Kline

    If I know my fellow Murricans a-tall, if forced to choose guns or butter they will emphatically belly up to Butter. Which is Reason No. 1 I am all for this hemi-demi-semi-depression thing: we may well put those dogs of war down fastest by starving the beasts.

    Regarding our ‘divisive’ politics, there is an effect which follows from a massive collapse in credibility; call it the ‘Katrina factor’ or coin your own catch-all. Dubya was exactly who and what he was from before his first day in Texas (at least policy- and noncompetence-wise), but his stock went hard south for good when he dropped the Baby Grand on that one. The plutocracy was hardly wiped out in ’29-’32: they came through better than most of the rest, but their credibility went negative, and the institutional political stranglehold they had maintained for sixty odd years fell down the privy hole for a generation. For most of the ‘middle class’ in the US now, having their home equity knocked down by six figures or out, and having the buying power of their wages massively slashed by cost inflation will be a perception change inducer. Whether ‘We were robbed,’ “We were lied too,” or “We were ill-led,” I couldn’t say but our politics will have a massive input toward realignments from past positions. Our politics may remain divisive, but ‘our divisive politics’ are a description of the past not the future.

    I don’t expect unity, not least because the MSM remains wholly controlled by super-wealthy, super-conservative interests (and I’m not talking conspiracy here, just to be clear), and they have no interest in muck-racking and the like. We’re more likely to get a ‘Progressive Era’ than a ‘New Deal,’ and I say that on many grounds as the better historical parallel. But Good Government will be at the top of the agenda, and that alone will be a massive redefinition from the politics of the last twenty years, where Bad Government, or better Badgovernment, was the only kind which was supposed to exist.

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