Bailout is necessary, but not a good thing

I wouldn’t pay attention to the short covering rally that the market experienced on Monday. And this rally may have some short term legs. But make no mistake about it, the government bailout of Fannie Mae and Freddie Mac has several negative implications for the economy, real estate and the stock market. Here are the main points:

1) The bailout should kill the dollar rally. Once foreigners start putting two and two together and realize that the government is on the hook for trillions of dollars of mortgages and could easily experience north of $300 billion in losses in the next three years, they will sell dollars. This makes our government’s budget even more shaky at a time that the government is being stressed by slowing tax receipts and increasing expenditures on medicare, social security and other social safety net spending.

2) As part of this plan, FNM and FRE will have to start reducing their portfolio with the goal of getting out of the market or being radically smaller. This will happen around 2010, but the market will anticipate this. This will force banks to keep more mortgages on their books or simply stop offering as many mortgages. This is yet another step in the de-leveraging the US economy will continue to go through and it is a huge negative for economic growth.

3) This bailout changes little for the average consumer who is being battered by lower home prices, heavy indebtedness and a rapidly slowing economy.

I understand the relief expressed by the market, but expect continued turmoil and tough times ahead for financial firms that will confront a higher regulatory burden, more fees from the government from such things as FDIC insurance premiums and dealing with keeping more loans on their books. The prospect for financial firms doesn’t look good for the next 3 to 5 years as the slow moving financial credit bubble gets unwound.