It seems like years ago the first shoe of the sub-prime mortgage/real estate collapse dropped with Bear Stearns selling itself at a massive discount as a way to get out of all the bad mortgage backed corporate paper they bought. This only happened in March. Now, it seems like the other shoe is falling with: (i) stories about Freddie Mac and Fannie Mae both being in financial trouble; (ii) The government stepping in and taking over IndyMac Bancorp, a California based bank worth an estimated $32 billion, due to a massive withdrawals of money by customers started by rumors the bank had too many bad mortgages on the books and would collapse (well, I did predict a mid-tier bank would go down in the 2nd half of 2008); and (iii) the Government of Canada changing the mortgage rules to eliminate the 40 year mortgage and the zero-down mortgage to prevent an American style real estate bubble (although some argue that the horse is out of the barn already). All this happened in 5 days. Wow.

The Freddie Mac/Fannie Mae rumors are the particularly frightening ones. Remember that Bear Stearns was solvent when it was sold; Bear Sterns could not over-come the market panic, short-term cash crunch and a lack of a short-term lender to bail them out which lead to their demise. It almost appears, to quote Yogi Berra, its deja vu all over again as we are seeing Bear Stearns part II. Freddie and Fannie buy mortgages off the banks so that banks can lend out more mortgages because they are not on their balance sheet; without them, the mortgage market would be considerably smaller and many people would not qualify for a mortgage. There’s really two things that can happen in this climate: (i) do nothing and hope the market comes to their senses; or (ii) government bail-out. Option (i) is not plausible in an election year (this post was written before the Feds announced Sunday night it would take steps to prop up Freddie and Fannie).

So what are we to make of these three events if we connect the dots.

1. Only a pollyanna would believe we are not in trouble in the short-term. It takes years for a traumatic effect like the subprime/real estate collapse to work its way through the system. Unlike the tech crash, where the damage was confined to day-traders, a real estate collapse and a banking crisis affects everyone on a day to day basis. Governments hate make it harder for the voters to do or get anything so you know that the Canadian government is worried if they are making it harder for us to get a mortgage; although the spin was very effective, a minority government changing the rules to make it harder to get something shows you how serious the issue is since this should be against every political instinct of a government seeking majority status.