tag:blogger.com,1999:blog-3782644139927778760.post-50076919896590007802008-03-09T05:16:00.000-04:002008-03-09T05:16:00.000-04:002008-03-09T05:16:00.000-04:00Wow. Fantastic find, Yves. I think the analysis of what is happening (the conversion of suspect agency debt into liquid and secure treasuries) is spot-on, but I don't think the target of this largesse is the banks per se (although that's definitely a fringe benefit).<BR/><BR/>Could this instead be the govt finally caving on the implied guarantee of agency debt? While every govt official has officially stated that Fannie/Freddie do not have a govt guarantee, no one believes the govt would allow those markets to fail. This would be a way of nationalizing that debt pool without "officially" doing so. Think of the Fed as the govt's SIV, carrying agency liabilities in an off-balance sheet vehicle: technically, the debt is not on the govt's ledger but if any of the debt on the Fed's ledger were to default, it has already been replaced with treasuries which <I>do</I> carry an explicit guarantee.<BR/><BR/>In this scenario, the Fed must prepare for a not-insignificant amount of its repo assets to fail. While I agree the default risk on overnight treasure securities is virtually nil, the risk of default in 28-day repos of agencies is distinctly nonzero, especially as these repos will likely be rolled over every 28 days for the next couple of years until bank balances are repaired and agency spreads come back down to historical norms.<BR/><BR/>But perhaps that's the point: allow banks to exchange their agency debt into treasuries on a semi-permanent basis, have the govt. assume the risk of default on that debt during these dark days, then return the debt at par to the banks when the markets have stabilized again. (sounds like socialize the losses, privatize the gains, no...?)Lunehttp://www.blogger.com/profile/07474032876924494925noreply@blogger.com