Fannie and Freddie

In 1938 and 1970, respectively, the US government created Federal National Mortgage Association or Fannie Mae and Federal Home Loan Mortgage Corp. or Freddie Mac, with the idea of providing home to people. It however, went a little too far when these mortgage houses started to buy from borrowers with poor credit rating. To make matters worse, the Congress directed these houses to lower their standards further for prospective borrowers, in order to compete with the emerging private sector, which was pushing hard into subprime loans. By 2008, $500 billion of the total $5.7 trillion of the loans Fannie and Freddie guaranteed or held were in subprime mortgages.

Now since the housing bubble has burst, the government is struggling to estimate the scale of losses. Even after extensive measures, the government is still left with a huge number of unsettled bad loans. The sum required to set the books in order is dependent upon the market situation. As Treasury Secretary Timothy F. Geithner puts it, “It’s very hard to judge what the scale of losses is.” An optimistic turn of events may require $160 billion. A further slump of 20 percent in the housing sector may however, pose a need of as much as $1 trillion.

The Obama administration is considering the idea of dividing all the loans among good banks with all the performing assets and bad banks with ill ones. Credit Suisse estimates the cleanup cost to the bad bank at around $290 billion, which will ensue from the taxpayers. The other alternative in sight is to let these companies default on their terms. Though, this can lead to a global turmoil and investors around the world may see US markets as the precarious ones for times to come.

The Republicans tried to push for amendment to slowly phase out the mortgage houses. A New Jersey Republican and a co-sponsor of the phase-out amendment Scott Garrett held the view that phasing out these houses will make it imperative for the government and market to deal with the issue directly, which currently is not the case. He asserted that without doing so, it would not be possible to judge the extent of damage.

There are divergent views on the issue however. It is said that keeping the houses would help the economy eventually. The National Association of Home Builders reported that the real estate market contributed 17 percent to the GDP in 2009. In addition, hoping for the private sector to fill up the huge gap is not seen as realistic. Whatever the way to deal with it is, purging the markets off the bad loans is going to cost the taxpayers a lot of money over several years to come.

Gold Rallies on the Back of Speculation

Economic instability has ever been a fertile ground for the appreciation of gold prices. One of the obvious reasons is the revamping of the investment basket by the investors on different levels. Economic turbulence has a strong bearing on most types of assets, including stocks and paper currency. During inflationary conditions, the paper currency begins losing its value relative to the goods and services, which makes them pricier. It is prudent, in such conditions, to substitute gold for at least a part of the total investments. This works as a hedge against the loss in the value of assets in hand. Interestingly, the same commodity is a hedge in the times of deflationary pressure on the economy. Deflation threatens erosion in the currency because of a lack of commercial activity.

In effect, the demand for gold shoots up in any type of volatile times on the economic scene. The demand-driven price rise acts as a positive indicator for speculators to pitch into the market. As nations are slowly propelling their growth engines after the recent global recession, the investors are whetting their risk appetites. However, speculating another impending crisis and consequent investment switch towards gold, the bargain hunters traded the yellow metal in large volumes on Monday, June 14, 2010. The disproportionately large sovereign debt in Greece became known earlier this year, followed by a bailout appeal by the Greek Government in April. The analyst opinions remain divided on the likelihood of a double dip, while the prospective bailout packages are being formulated and negotiated. The uncertainty in the Euro Zone has created widespread concerns among the investor funds, banking corporations, Governments, and the retail investors, alike. Consequently, gold is yet again being viewed as a safe haven for investment and hedging.

Euro has taken a beating with a loss of approximately 7% in value, in the month of May. Back home, the US national debt is over $13 trillion, forming a sizable percentage of the GDP. The impact is a weak US Dollar. For long, Euro and gold were seen as alternatives to Dollar. A sliding Euro has propelled the demand for gold even further. The entire demand is not coming from the speculators and the institutions, but they are fuelling a large part of it. The mixed sentiments towards the economic recovery were evident last week, when gold touched a record high of $1,251.20 before plunging to $1,214. Afshin Nabave of NKS Finance expects gold to cross $1,250 once again and approach $1,300 in the due course.