The news regarding Fannie Mae and Freddie Mac seems to have come and gone faster than it took Michael Phelps to earn his heroic eight gold medals in Beijing. Though riveting to start, not a whole lot of thought seems presently devoted to the effects on the economy over the next 12 months, nor the consequences of a possible federal takeover.

Built on a noble business model of supporting the American home ownership dream, companies Fannie and Freddie, so affectionately known, have gone from respected industry giants to firms on the brink of extinction.  Companies that have shown to be flawed on so many levels have added to the national debt a sum greater than all the wars this country has been engaged in since WWII.  This comes at a time when executive management is still receiving huge bonuses based on non-existent profits; such faulty accounting practices were long hidden, successfully, until the Administration finally stepped in and forced revelation.  On a live blog posted this week by Warren Buffett, he stated that “they [Fannie Mae and Freddie Mac] were able to borrow without any of the normal constraints.  They had a blank check from the federal government.”

With more than 3 million homeowners scheduled to foreclose on their homes this year and over half of all outstanding mortgages controlled by Fannie and Freddie, the US faces a housing and mortgage crisis unlike any other in history. The concentric circles that are now spreading and spiraling outward can no longer be limited to the housing sector and will affect almost every aspect of our economic lives.

How the problem is dealt with will be a critical factor in the month of August as the nation waits on the precipice of a government bailout that continues to support the notion that some companies qualify for the label ‘too big to fail’.

While this step would bring some short term stability to the markets, shareholders in Fannie Mae and Freddie Mac can expect to see continued losses beyond the +90% that has already been wiped out since October of last year.  Taxpayers will now be on the hook for billions of dollars to offset these enormous losses as the effects become continually compounded. To add to this, the national debt will be greatly revised upward, and the government will face increased costs of borrowing as vehicles once deemed safe investments are burdened with a large asterisk beside them. International relations strained from purchasing over $1 trillion of debt under the guise of being as solid and trustworthy as US Treasuries will only continue to add to the problem over the next few years as the markets attempt to regain stability.

As global eyes turn away from Beijing and the markets’ typically quiet summer months come to an end, domestic attention will turn back toward our economy as we await news about the fate of two of its stalwarts. Those paying attention will be carefully looking at how the next acts play out in order to get a glimpse around the curve for what lies ahead.

Keep posted for an update on the outcome…

David McMillan

Click here for David McMillan’s article on Seeking Alpha addressing Alternatives and Absolute Returns with ETFs.

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