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Against the Tide: Socializing risk is not a long-term cure

Short of a radical restructuring of the banking sector, the US government bailout will prompt a market rally. However the longer-term effects will be deleterious.

The US now has the most socialist financial system in the world outside of North Korea and Cuba. The government takeover of government-sponsored mortgage lenders Fannie Mae and Freddie Mac means that the state now owns 75% of the US housing finance market.

At the same time, the Federal Reserve is providing nearly $300 billion of cash to finance the takeover of investment house Bear Stearns (last March), to provide liquidity for banks, investment houses and brokers in return for all the toxic mortgage-backed securities they own.

The US treasury has taken on to its books $5.2 trillion in Fannie Mae and Freddie Mac liabilities, nearly doubling the debt that the government must finance through the budget. The US government’s debt as a percentage of GDP will thus rise from about 40% to nearly 80%, easily surpassing the majority of European governments’ debt burden.

That is not the end of it. To provide compensation for depositors if their savings come under threat when banks go bust, the Federal Deposit Insurance Corp must rely on monies and lines of credit from the US Treasury. It is going to be badly short of funds soon and will have to ask the government for up to $70 billion.

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