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Fed official admits the emperor has no clothes!

Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
Peter Schiff
Monday, March 10, 2003

St. Louis Federal Reserve President William Poole finally stated the obvious when he said that Fannie Mae and Freddie Mack "may not be sufficiently capitalized to weather a financial shock," that they "pose a risk to the financial system and the U.S. economy," that they "hold capital far below that required of regulated banking institutions," and that "the government should make clear it doesn't back the firms."

Such profound admissions from so credible a source could well be the pin that finally pricks the housing bubble. America's foreign creditors have been ignoring the risks inherent in the debt of Government sponsored enterprises because of the supposed existence of an "implied government guarantee." The sudden realization that no such guarantee exists could cause a wave of selling in these instruments, sending mortgage rates soaring. Without access to cheep and plentiful mortgage credit, the entire U.S. bubble economy will implode.

One has to wonder why Poole is making these comments now? After all, the implications of these admissions are staggering. Together Fannie & Freddie insure about 50% of the home mortgages in the United States. What is even more incredible is that Poole is actually underestimating the problem. It is not that Fannie and Freddie can not withstand a "financial shock," they can not even withstand the normal course of business. These two entities are so highly leveraged that even a minor recession with a relatively small increase in interest rates, and a modest decline in housing prices, would send both into bankruptcy. Food for thought.