Safe Investments? Getting Harder to Tell What is "SAFE"

Soothing government dialog not always helpful

September 13, 2008
By: Jerry Cole - Retirement, Investment

Safety is defined by the dictionary as the condition of being safe from undergoing or causing hurt, injury or loss. In the investment world it is getting increasingly difficult to determine what investment is safe and what investment isn't safe. To be sure everything in life carries some risk, but when U.S. government officials keep offering a steady stream of soothing dialog regarding the financial condition of certain entities, you have a tendency to believe it's true!


I am speaking to the recent bailout of mortgage giants Fannie Mae and Freddie Mac Not long ago, Treasury secretary Henry Paulson issued assurances that the government-sponsored mortgage companies would raise more capital if needed. Further, at a U.S. House of Representatives hearing in July Mr. Paulson said that the federal regulator overseeing Fannie and Freddie "has made clear that they are adequately capitalized." Mr. Paulson was also quoted as saying that Fannie Mae and Freddie Mac "must continue in their form as shareholder companies."

Well if you were a common shareholder going into last week-end when the government took over the two companies, you got the royal -----. After the government seized control of the two mortgage giants, prices of their common shares tumbled more than 80%. By late this last week, common shares of both companies traded at less than a dollar.

So who wins in a situation like this? Hopefully the takeover and restructuring of the two mortgage giants will lead to a rapid recovery in the real-estate market and a rebound in economic growth as well as a surge in lending by a newly confident banking sector. But perhaps the biggest winners will be China and many other developing economies of the world. This wasn't necessarily the intention of the Treasury Department, but it true however.

The rescue bails out the banks and central banks that had put too much money into mortgage paper backed by Fannie and Freddie. At the end of 2007, Chinese banks held $376 billion in what financial markets call agency debt. Now the commercial banks in China - and the Chinese government - don't have to worry about problems at Fannie and Freddie turning into problems on their balance sheets.

Now the $5 TRILLION in liabilities from the Fannie and Freddie takeover could rightfully be added to the books of the government's total debt. That basically doubles the national debt and can't help but push the U.S. dollar lower and interest rates higher in the long term. The U.S. government is going to have to sell more Treasury bonds to cover its new debt.

The bottom line is this country is going to have to speed up its time line for energy independence and increase productivity even more if we are to stay the leading power in the world. We are going to have to put in the checks and balances of our system so that an outrageous escalation of values such as we recently experienced in the real estate markets cannot take hold. We have to get back to where safety in our country is really safety!

In the meantime be sure to keep your risk within your tolerance and keep ahead of inflation.

I invite your questions.

(The opinions expressed are solely those of the author and not Gen worth Financial Securities Corporation or of www.mybaycity.com)