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Farrell: Throwing the Dollar Under a Bus

Federal Reserve Chairman Ben Bernanke threw the dollar under the bus yesterday.

In trying to achieve market stability, he ... and Secretary Paulson ... only rattled the cage. I believe the market sold off on the belief that if we aren't going to defend our currency, why would anyone bother to buy financial assets denominated in that currency.

I understand the pressures being faced with the collapse of Fannie Mae and Freddie Mac , but those stocks have to sink or swim on their own. Stabilizing the multi-trillion debt market behind those companies can be done without bailing out the stockholders. I think Paulson is only too willing to let the stocks get to zero, but seems to be constrained from acting. I think that raising new capital should not be up to the companies. Since they need Fed backing they have surrendered control of their own destiny and should be forced to run their book off. The two get about $25 billion in mortgage repayments each month and as that comes in they can replenish their capital needs. They should not be allowed to relever and do it all over again.

One of the arguments against this is the need to supply the mortgage needs of the nation. 240 years ago Frederick the Great of Prussia (I got the history from the Financial Times) introduced the concept of "covered bonds" to allow his ravaged nation to recover from the devastation of the Seven Years War. A bank takes the mortgages it issues and bundles them into a mortgage bond, but keeps it on its balance sheet. The buyer of the bond has the stream of mortgage payments and the credit of the bank as security. Imagine, underwriting discipline would need to be employed since you (the bank) will be liable for the paper.

With two sources of repayment to secure the bond, capital required would not be onerous. There is an ocean of liquidity in the world looking for quality investments. The five largest sovereign wealth funds are believed to have over $2 trillion in assets and money market funds have well over $3 trillion. This vehicle is used in Europe and over $2 trillion in bonds have been issued.

So the mortgage market will revert to the private sector and FNM and FRE can figure out their own equity survival. Quality investment opportunities will attract investors if you have a stable currency. Defend the dollar, oil will move lower since it's priced in dollars, and inflation will be attacked.

(For more market discussion, see the videos).

William Ackman: A Plan to Save Fannie and Freddie

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