Does this really promise big change in the course of U.S. financial markets? After all, both companies trade on the New York Stock Exchange. The basic idea is that these companies supposedly belong to shareholders. These shareholders are owners just like the guy who owns the gas station on the corner or the husband and wife team that runs the French bistro on Main Street.

But Fannie and Freddie were never really private companies like these others. Entrepreneurs usually start businesses. Congress created the mortgage giants by charter (hence, they are called government-sponsored enterprises, or GSEs). And the two giants enjoyed many advantages from that parentage. Fannie and Freddie have long operated in a sort of limbo as a result, neither fish nor fowl. Both carry the implicit guarantee that if something went truly wrong, the government would come along and make it right.

And so it has. Bondholders are happy today. Stockholders are not. Fannie Mae fell 90% on Monday, and Freddie Mac fell 83%. I have no flag in either camp, but I certainly have no sympathy for the stockholders. Anyone who gave them a fair look could see that both GSEs were ticking time bombs.

In fact, I wrote an essay for the Mises Institute titled “Mortgage Market Socialism” way back in 2002. I pointed out the dangers of the growth of these GSEs far outpacing that of the mortgage market. If I may quote: “The longer the GSEs are able to expand as they have, the more certain it becomes that someday taxpayers will have to bear the cost of such excess.”

This is one of those times when I am not happy to have gotten it right. Taxpayers — of which I am one — will now pay for these mistakes. Yet despite all of the hubbub in the papers, this is nothing new.

This action by the U.S. government does not really signify any sea change in financial markets. It’s just another step in a long journey on the same path. If you read financial history, you come to appreciate this overwhelmingly powerful trend. As Freeman Tilden wrote in his 1935 book A World in Debt:

“The whole progress of the legislative attitude toward the debtor, from the Roman Republic to the present day, has been steadily, though with occasional backward lapses, toward making debt easier to incur, lightening the burden of carrying and softening the consequences of default.”

The fancy modern words for this process are the “democratization of credit” and the “socialization of risk.” Another excellent historical study of this process is James Grant’s Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken. It is beautifully written, for one thing. And it will show you this process has been going on for a long, long time.

I know the above is a bit off my usual beat. We are about making money in the more obscure nooks and crannies of penny stocks. But this event deserves some sort of comment — mainly because I believe all of the newspapers have missed something. They have all missed this bigger point: This huge trend snakes its way through financial history.

What does it all mean and how does it all end? I suspect we are on a path similar to that of Argentina. One day, we’ll have some major Argentine-style financial crisis. We’ll have Argentine inflation and a similar loss of faith in the banking system and the currency. The government will chew away and destroy a lot of wealth in the process.

Hopefully, I won’t quote myself on that someday soon. In the meantime, though, I think one of the best things an investor can do is focus on buying useful and tangible assets that ought to hold their value against a depreciating paper currency. These assets include oil and gas, metals and minerals and land and water rights. The shares of the companies that own or find these assets ought to do well. Commodities will have their day in the sun once again.

So hang tight, and we’ll let you know when the next investment opportunity comes around.

Sincerely,
Chris Mayer
September 10, 2008

Predicting Fannie and Freddie Would Fall was originally featured in the Penny Sleuth.