Additionally, despite the euphoric reactions of the stock and bond markets to the Fannie/Freddie bailouts, some negative fallout is coming to light. First of all, foreign owners of agency debt in the GSEs are getting preferential treatment over US equity holders. Assurances made by the US to foreign central banks and sovereign wealth funds may have prevented a run on the dollar, but come at the expense of US based preferred and common shareholders.

As highlighted in yesterday's commentary, US financial institutions are faced with the prospect of writing down the value of shares in Fannie and Freddie. An FT blog post notes that US regional banks are particularly vulnerable as they apparently own about $36 bln worth of preferred shares in the GSEs.

Shares in Fannie Mae plunged to close at $0.73 on Monday, a 90% drop from Friday's close at $7.04. Freddie Mac didn't fare much better, closing at $0.88, down 83% from Friday's close at $5.10.

Just to put the demise of the two mortgage giants into a little better perspective: Fannie Mae was trading at $62.79 a year ago and began this year at $40.20. Freddie Mac closed on 10-Sep-07 at $58.75 and began trading on 02-Jan-08 at $34.42.

The GSE rescue has also precipitated the default on Fannie and Freddie Credit Default Swaps (CDS). While the government now secures the debt, these derivatives trades are still going to have to be unwound at a loss. The actual value of outstanding CDSs are unknown, but the cost will be in the billions of dollars.

One has to wonder if other financial institutions might require bailouts or fall into the hands of the FDIC as a result of the Fannie/Freddie rescue. Either way, the American taxpayer will ultimately bear the burden.

The takeover of Fannie and Freddie is also going to have a negative impact on the federal budget deficit. Based on new estimates the budget deficit is predicted to be $407 bln this year and could grow to a record $438 bln next year. Given that the cost of the GSE bailout is still unknown, these numbers could end up being substantially higher.

In the long-run, the nonpartisan Congressional budget office said, "the federal budget is on an unsustainable path." And yet the deficit spending continues. I saw a post on one of the message boards this morning that asked if the Fed and Treasury were approaching the limits of their abilities to bail out failing firms.

Sadly, the answer to that question is that their abilities are only limited by the amount of paper and ink they can feed into the printing presses. The Fed and Treasury can create as much money as necessary to provide bailout capital and funds to service our ever-growing debt.

Which brings us back to the burning question about the sustainability of the dollar's rally. Given the dismal fundamental economic outlook, there certainly seems to be a fair amount of irrational exuberance circulating in the dollar, stock and bond markets. There seems to be a prevailing sense that the housing/credit/liquidity crises are far from over.

The fact that we've seen an increase in risk appetite in the wake of the GSE bailout highlights the much-discussed moral dilemma associated with the government stepping in and essentially rewarding behavior. Of course that didn't help holders of FNM and FARE common and preferred shares, so the market may just want to rethink their position.

Gold remains the ideal hedge against systemic risks and the likelihood that the dollar's long-term downtrend will eventually re-exert itself. These suppressed prices provide buying levels not seen since late last year.

Mike Kosares, the President of USAGOLD - Centennial Precious Metals has written another excellent essay that identifies "Six Situations to Monitor for the Rest of 2008" as they pertain to the gold market. While the GSE rescue has stolen the headlines this week, there are plenty of other reasons to be considering a physical gold purchase at these levels.

Gold Market Movers:

Who is taking the big hits on Fannie, Freddie shares?

US move triggers CDS default

Budget deficit nears record under latest estimates

Commercial real estate: The next big credit problem