INVESTING: Woes of Fannie, Freddie overshadow bank calamity

Wall Street often is nothing more than a game of three-card monte, with the majority of players losing because they were looking at the wrong card.

It is challenging enough to make money during bull markets. But during bear markets, the distractions and traps are everywhere, and they are lethal. There is a big distraction right now that is masking what could be the falling domino that sends everything else toppling over.

The disaster of the month is the near-collapse of Fannie Mae and Freddie Mac, two of the largest mortgage buyers in the world. Together, they account for half of all mortgage purchases in the United States.

Both companies are drowning in the subprime slime, and our government has just announced that its implicit guarantee of the two governmentsponsored entities is now explicit.

As that drama was unfolding, a regional bank in California, IndyMac Bank, went under-news that received relatively little attention. The Federal Deposit Insurance Corp. is being called in to pay off depositors who had less than $100,000 in the bank. Early estimates for the total cost to the FDIC range from $5 billion to $8 billion.

But that is what the FDIC is there for, right? Yes, but in the modern world of high finance, nothing is what it seems. The cards are beginning to move fast now.

The FDIC has only $52 billion with which to pay insurance claims against it. There will be a few thousand depositors at IndyMac who had more than $100,000 on deposit, and they won’t be getting that money back.

If some small, no-name bank with 29 branches is using up more than 10 percent of the entire backstop of the FDIC, what is going to happen when a few more regional banks go bust, as will almost surely happen before this cycle is complete? And by the way, I fully expect at least one large institution to fall within the next 12 months. Stew on that for a minute as you think about “staying the course.”

The shenanigans of Bear Stearns in March and now the unfolding disaster of Fannie Mae don’t directly affect average Americans and their daily lives. Sure, the ripples cause changes, but the cards are moving so fast that most people feel them only in subtle ways. But you get a good, old-fashioned run on the U.S. banking system, and Joe Sixpack is going to feel it, and fast.

It is a crisis of confidence, but a crisis that is going to be difficult to deal with. In the 1930s, our government had little debt and a coming world war to help bail out the system. Today, our debt levels and current obligations mean fixing this ship is going to be a long, drawn-out affair.

My worst-case scenario: Several regional banks and a few big players go bust within a short time frame, perhaps 18 months. Along the way, there will be times when everything seems fine. But until you see buyers getting very aggressive in the stock market for days at a time, the best bet is to stay away. The stock market will tell us when the storm passes. But I think it is safest to carry an umbrella while you can still hear the thunder.