The huge threat to the US economy

You'd be absolutely right on the facts. And dead wrong in practice. You see, when you're a debtor, it's what your creditors believe, not any fact, that is important. If your creditor believes you might not be able to pay, it's that belief that counts, no matter the facts, when the creditor cuts off your credit. What a creditor believes is especially important when a debtor needs that creditor to keep extending credit in the future to finance new bills. That's, of course, exactly where the U.S. finds itself now.

What the US must do

What happens over the next few weeks or months is critical. If the U.S. government comes up with a credible plan to recapitalize Fannie Mae and Freddie Mac using government and private money -- even if the private money is mostly window dressing -- then overseas investors will be reassured that the U.S. isn't simply going to walk away from its financial obligations.

If that plan includes tougher regulations and stricter limits on leverage, and especially if it replaces current management at the companies, overseas investors will gain confidence. If the plan includes an equity element, so the U.S. government (and taxpayers) have a chance to profit from a recovery at these two companies, overseas investors will start to believe the U.S. has faith in its own future. And if the plan includes a timetable for reducing the size of or, better yet, eliminating Fannie Mae and Freddie Mac, overseas investors might actually start to believe the U.S. government is in control of its own future.

Certainly, it makes no sense from any perspective to let two private but publicly traded companies have as much power over the U.S. financial markets and the credit rating of the U.S. government as Fannie Mae and Freddie Mac do. Especially since the financial markets are so much deeper now than they were in 1938. The big banks and other investors are perfectly able to provide the liquidity that Fannie Mae was designed to provide in 1938.

Possible consequences

And if the U.S. doesn't come up with a credible plan? To protect their own interests, overseas investors will increase the rate at which they're moving away from the U.S. dollar.

In the short run, that means a cheaper dollar -- good for U.S. exports but bad for U.S. consumers who will have to pay more dollars for everything this country imports, including oil. In the longer run it means underperformance by U.S. stocks and bonds because overseas investors will want to hold fewer of them. It means higher interest rates because the U.S. government will have to pay more to get overseas investors to overcome their reluctance and buy our debt. And it means slower economic growth from higher interest rates and an increased cost of capital to U.S. companies that want to expand their businesses.

What's happening at Fannie Mae and Freddie Mac wouldn't matter so much, of course, if the U.S. didn't owe so much to the rest of the world. But it does. The sooner we realize that the two most important jobs a debtor has are successfully managing creditors and getting out of debt, the better off the U.S. will be.

Developments on a past column

"The great Google-Nokia-Apple war": On July 17, Nokia (NOK, news, msgs) quashed worries that a soft global economy would take a bite out of sales at the world's largest maker of cell phones.

For the second quarter of 2008, the Finnish company reported that revenue had climbed by 4.5% from the same period in 2007. Earnings per share came in at 36 cents a penny above Wall Street projections. The company said global sales of cell phones would climb by 10% or more in 2008.

Nokia reported that its average selling price had dropped in the quarter to 74 euros from 79 euros in the second quarter of 2008. That can spell disaster for a company because it's bringing in less money on each phone it sells. But Nokia was able to increase its operating margin to 14.7% from 11.1% in the second quarter of 2007. Despite the drop in selling price, Nokia actually made a bigger profit on its phones.

The company's market share climbed back to 40%, up from 39% at the end of 2007. All this comes before the company launches its Comes With Music subscription download service and before it begins selling touch-screen handsets designed to compete with Apple's (AAPL, news, msgs) iPhone.

As of July 22, I'm keeping my target price at $37 a share by June 2009. (Full disclosure: I own shares of Nokia in my personal portfolio.)

Editor's note: Jim Jubak, the Web's most-read investing writer, posts a new Jubak's Journal every Tuesday and Friday. Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment, see Jubak's portfolio of Dividend Stocks for Income Investors. For picks with a truly long-term perspective, see Jubak's 50 Best Stocks in the World or Future Fantastic 50 Portfolio. E-mail Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Nokia. He did not own short positions in any of the equities mentioned in this column.

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