What the Fannie-Freddie rescue means to you

Now think about that for a minute. Regulators essentially said: We'll let you borrow 30 times your assets. If you blow it, we'll back you and give you more. If your bets work out, you get to keep the winnings.

Who in their right minds wouldn't have taken that directive and gone straight to Las Vegas? And that is essentially what the executives at Fannie Mae and Freddie Mac did, ultimately buying up to half of all mortgages written in America and using the proceeds of the bond sales to provide lavish incomes to themselves, rich consulting fees to former congressmen and government officials and big donations to current representatives and senators.

That was all good as long as mortgage holders paid on time, but now foreclosures are rising at a record rate, and the cash flow to pay off on the interest owed to investors is drying up. Real losses are mounting, and that has led investors to sell now and ask questions later. The two organizations need lots of capital to shore up their base. And the real problem is they're not alone -- far from it.

• Slide show: The bear market blues

Institutional research firm Bridgewater Associates has estimated that U.S. and European banks need $1.6 trillion to fill the hole blasted by losses in mortgages. But the analysts another top firm, TIS Group in Minneapolis, believe the real amount of new capital needed is $3 trillion to $5 trillion.

How could it be that big? It's the leverage. At a 30-1 ratio of real assets to loans, you only need a 4% default rate on the loans for all your capital to disappear.

Since corporate defaults run at 4% in a recession, according to TIS Group analysts, the U.S. banking system is going to have to raise truly massive amounts of capital or very rapidly dial back lending to levels seen before 1995. And you just have to wonder where this new capital is going to come from.

The sovereign wealth funds of Asia and the Middle East are already down 40% to 70% on the purchases of Citigroup (C, news, msgs) and UBS (UBS, news, msgs) that they made in December and January. And they are not in any mood, according to my sources, to throw good money after bad. Maybe the Russian energy oligarchs will put up rockin' amounts of rubles, but I doubt even they are so crazy.

Now the only way out appears to be some sort of scheme where the government nationalizes part of the U.S. banking system and prints money to do so. That way they can directly inject money into the banks while wiping out current shareholders.

Something like this happened in Japan a few years back, and it worked to an extent.

No one really wants the United States banking system to fail. But if you're an equity investor, the main message today is that even at today's very low levels, most banks and brokerages are far too expensive to touch.

They may have fat dividend yields and low price-earnings multiples, but they are going to have to lower current earnings estimates to big losses and cut their dividend payouts completely. Many will go broke, and most can fall an additional 50% from today's levels.

Meet Markman at The Money Show

SuperModels columnist Jon Markman will be among more than 50 investing experts sharing tips and techniques at the 30th anniversary of The Money Show in San Francisco, Aug. 7-10. More than 150 free workshops will help refresh your perspective and prepare you for whatever the market does next. Admission is free for MSN Money readers.

To register, call 1-800-970-4355 and mention priority code #009552, or visit the Money Show San Francisco Web site.

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