Financial Zombies – The Recession’s Walking Dead

| January 8, 2008


Lost in the Election and Brittany din, the cold wind of recession is starting to blow hard enough that even the mainstream media types are starting to see smell it. Worse yet the deflation triggers are continuing to fire faster and harder since Christmas. Some of the facts:

  • The Dollar continues to weaken against other major currencies
  • he largest and best known financial companies continue to declare massive, and growing losses
  • Talk of insolvency among the biggest names in finance refuse to go away
  • Central banks across the world continue to act together to continue to flood liquidity into the world markets

What we face now is an interesting time when the first shock wave of what is likely to happen to the world economy has already happened. Many large companies, such as Countrywide and Citi, may in fact be insolvent should they have to reconcile everything they have off balance sheet, and everything that they may be using creative accounting to tally.

It could be that some of our biggest brand names in the world of finance (let’s face it, this is one of the few things we have not out-sourced or NAFTA’d away) could in fact be technically dead, though they still walk the earth doing business. We can think of them as Financial Zombies.

As Mike “Mish” Shedlock (A Minyanville professor, and rightly so) points out in Market Does Not Believe Countrywide’s Denial, the markets are catching rumors that Countrywide may be forced to confront the fact that they are bankrupt.

Like people hopelessly underwater on their flipper mortgages and credit card debt, Countrywide is refusing to face the music and work things out. Like the people who gambled hard on the housing market, they are hoping against facts and reality that things will turn around “really soon” and they can recover. In fact for the last 2 decades or so, kicking the can down the road more times that not has actually worked out. This time it may not.

If Countrywide going belly up sounds bad, consider for a moment what might happen if one of the Government Sponsored Enterprises, Fannie Mae or Freddie Mac, were to join the Zombie ranks. Alarmist propganda? Maybe, but lets look at some facts from the St. Louis Fed:

The bulk of all GSE assets are in the housing GSEs—Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks. Using information as of Sept. 30, 2006—the latest available as of this writing—these 14 firms have total assets of $2.67 trillion; given their thin capital positions, their total liabilities are only a little smaller. Just two firms—Fannie Mae and Freddie Mac—account for $1.65 trillion of the assets, or 62 percent of all housing GSE assets. Moreover, Fannie Mae and Freddie Mac have guaranteed mortgage-backed securities outstanding of $2.82 trillion. Thus, the housing GSE liabilities on their balance sheets and guaranteed obligations off their balance sheets are about $4.47 trillion, which may be compared with U.S. government debt in the hands of the public of $4.83 trillion.

Fannie and Feddie finance long term debt (mortgages) using clever trading of short term instruments. The leverage they employ his massive, and further more the St Louis Fed cites:

Fannie Mae and Freddie Mac pursue policies that inherently expose the firms to an extreme asset/liability duration mismatch. They hold long-term mortgages and mortgage-backed securities financed by short-term liabilities. Given this strategy, they must engage in extensive operations in derivatives markets to create synthetically a duration match on the two sides of the balance sheet. These operations expose the firm to a huge amount of risk unless the positions are measured at market value.

This is the same trap that has caused so much havoc in the mortgage backed bond market. While the Fed states that there is no imminent crisis in the GSEs, they also warn that it is not “unthinkable”.

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Category: Economics, Main, Recession Watch

About the Author ()

Bruce Henderson is a former Marine who focuses custom data mining and visualization technologies on the economy and other disasters.

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