Oh Boy, Here We Go.

There is a prophet out there with both authority and a national voice, and his name is John Talbott. Talbott's BOOKS completely nailed what was then to come, and has since come to be. And I mean everything. Failure of the sub-prime market, catastrophic drop in capital available to lenders due to over-extended leveraging, etc. etc. But nobody listened.

I tend to be a pessimist when it comes to economics. Unlike when I play cards, I don't like to gamble and I like to look at all the facts in a calculated way. When others were screaming 'Buy!', I was saying 'Um, the ratio of median home value to head of household income is surpassing 10:1, and the last time that happened was 1928--I don't think we should be buying right now.' Still, I almost got into the act in 2006. I had been weakened by everyone's blind optimism, and was seriously thinking about getting into the housing market lest I were stuck as a California renter all my life. Thank God a good friend gave me some advice: read Talbott.

Of all Talbott's prophetic opinions, the scariest and most potentially damaging was the failure of Fannie Mae, Freddy Mac, and Ginnie Mae. The three together are holding roughly $6 trillion in mortgages. Yes. That's right--with a T.

Moreover, they are leveraged between 70 and 120 times their total equity. The Basel Accord of 1988 states that international banks need to cap residential mortgage portfolio leverage at 24:1. So, how do the FMs have such high leverage? Because they don't have to comply to the Basel Accord...they're privatized, but are still under an unwritten governmental umbrella. So they could do what they wanted without oversight. And they did.

Now that INDY MAC (unrelated to the FMs) has failed and Uncle Sam has stepped in, the question isn't 'will the government come through on its unwritten policy to back Freddie Mac and Fannie Mae if they go too', but rather: 'where does the money to do it come from when it does happen'? The national debt is $9 Trillion. And we'd add another $6T? Take a look at FREDDY MAC'S and FANNIE MAE'S share values. They skyrocketed in the 90's, and yet have lost everything in the last 9 months. This is going to be much, much worse than the S&L issues of the late 80's. Sure, the bonds are safe and only getting better, but that won't save everything. Applying a little bit of basic Adam Smith, I see there are two scenarios (but I'd like to hear what you all think):

Scenario 1. Goverment pumps a boatload of money into the Mae/Mac Machine. They buy a bunch of shares and prop up the two lenders. This would in the short term keep them solvent. But this is an internal fixing a system. For all non-biological creatures, the only way for a system to change is for an external force to be applied. The government taking tax dollars to prop up Mae/Mac is robbing Peter to pay Paul. And Peter will soon find out. Taxes will go up to compensate, (and when Obama is elected, they'll skyrocket), and the wealthy will stop developing economic interests, which will dry up the market, companies will lose money, and people will get laid off in huge numbers. You lose, thanks for playing.

Scenario 2. Government does not pump a boatload of money into the Machine. Thus Mae/Mac freezes. They are unable to borrow money to guarantee new mortgages. Bear in mind they have their hands in 70% of mortgages. That means a huge number of mortgages simply won't happen. This will absolutely crush worker mobility, and capitalism is built on the principle of worker mobility. If workers can't move, then jobs can't be filled, then products can't be produced, then profits can't be made and then more jobs will be cut, thrusting the system into extremely high unemployment. You lose, thanks for playing.

So, in 9-18 months, when you're out of a job and looking for something to fill up your days, I highly suggest reading Talbott's stuff, especially "The Coming Crash in the Housing Market" (2003), but by then you might find his books in the History section rather than under 'Economics'.