Now it looks like that has happened.
Fannie and Freddie have 233 Billion of debt that no one will touch, except us, dear reader, the US taxpayers. Thus, they're toast; we're all toast. Let's be toast together!
Our risk case scenario is that the U.S. dollar begins to fall precipitously coinciding with a riseNorthern Trust prediction of US economy, July, 2008
in Treasury bond yields. U.S. inflation does not moderate because of the depreciation in the
dollar. As a result, the Federal Reserve is forced to raise the funds rate even in the face of a
rising U.S. unemployment rate. This would be “checkmate” for the U.S. economy, turning a
relatively mild recession into a severe one. Why might the dollar dive? Because the U.S.
Treasury is forced to issue more debt in order to recapitalize either Fannie/Freddie/ the Federal
Home Loan Bank System/FDIC, and the rest of the world balks at being the buyer of last
resort for U.S. government debt. As this is being written on Friday, July 11, a hint of this is
happening. Rumors are swirling that the U.S. Treasury will have to recapitalize Fannie Mae
and Freddie Mac. Rather than resulting in the usual flight-to-quality bid for U.S. Treasury
securities, yields on Treasury coupon securities are rising and the dollar is falling. Another
factor that could precipitate a further sharp decline in the dollar might be the severing of the
pegs that foreign monetary authorities have maintained between their currencies and the U.S.
dollar. The byproduct of these pegs has been upward pressure on the inflation rates in these
foreign economies. If these monetary authorities can no longer tolerate this imported inflation
and sever their currency pegs to the dollar, the dollar would likely go into a tailspin.