According to Moody’s, the ratings implicit in credit default swaps on Fannie and Freddie treat the government-sponsored enterprises as if they are mere single As, versus their official AAA ratings.
Now the real question is: do these marks reflect doubts about whether the implicit government guarantee will be honored, or is this an early warning traders’ worries about the creditworthiness of the US government? So far, it appears to be the former.
Note a continued vote of no confidence in federal initiatives to use the GSEs to guarantee more debt to assist the housing market. Congressional discussion of bailout plans spurred sharp increases in agency bond spreads in January, which led to the creating of new facilities to try to bolster that market.
From Bloomberg:
Fannie Mae and Freddie Mac, ranked Aaa by the world’s largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower.
Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody’s Investors Service….The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months.
Traders are overlooking the government’s tacit guarantee of the debt as credit losses grow and concern rises that the companies don’t have enough capital to weather the biggest housing slump since the Great Depression. Even an implied guarantee isn’t enough to convince credit investors that there’s little risk to owning Fannie Mae and Freddie Mac debt, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.
“Investors are viewing even an implicit guarantee from the government as potentially troublesome,” Backshall said….
Fannie Mae and Freddie Mac, which reported combined losses of more than $11 billion, have raised more than $20 billion since December. Merrill Lynch & Co. analyst Kenneth Bruce said in a report yesterday the “highly levered financial institutions” will have pretax credit-related losses of $45 billion.
“Fannie and Freddie are going to have to raise more capital and nobody thinks they’re going to be able to raise capital when they need to,” said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia. “It’s going to be very expensive.”….
“It concerns me that people sort of extrapolate well beyond what the facts are,” James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, said in an interview with Bloomberg Television yesterday….
The bailout of Bear Stearns Cos. arranged by the Federal Reserve in March shows the government won’t allow the companies to fail, Robert Millikan, who manages $5 billion as director of fixed income at BB&T Asset Management in Raleigh, North Carolina.
“We’re looking at it from a standpoint of, if the Fed is not going to allow a problem with Bear Stearns, they’re certainly not going to allow a problem with Fannie and Freddie,” Millikan said. “With all the exposure that banks have to Fannie and Freddie, the ripple effect through the whole financial system would be unbelievable if they were allowed to fail,” he said.
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I also liked this part:
“The companies’ congressional charters provide exemption from state and local corporate income taxes and give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default. Fannie Mae spokesman Brian Faith and Freddie Mac spokesman Michael Cosgrove declined to comment.”
>> I’m sure Mike was caught unaware with that, just as Mr. Brown was caught off guard by Katrina, as FEMA employees were looking at catering menus and doing other stuff. Heck of a job Mick!
“The bailout of Bear Stearns Cos. arranged by the Federal Reserve in March shows the government won’t allow the companies to fail…”
This is the most blatant evidence of a moral hazard problem. The passing of H.R. 3221 (sec. 257) and it’s provision for a $300 billion dollar bank bailout is going to have major repercussions.
Parties are likely to take riskier bets if they think the government is going to cover their mistakes like this
The question is what a bailout of the GSE would be worth. Sooner or later the currency will collapse and with it the regime. What will take its place. Most likely the new currencies will be drugs, cocaine, heroin, etc and the new regime will be lead by MS-13. Viva Che.
Couldn’t this just be the result of hedging? “Long the stock, short the swaps” might make for a good trade.
Fannie and Freddie own or guarantee almost half the 12 Trillion $ mortgage market. If anyone thinks we won’t end up nationalizing these two GSEs if faced with their demise, they have rocks in their head. The consequence of their demise would be unimaginable, particularly on foreign confidence considering so much of their debt is held abroad. We wouldn’t be able to borrow another wooden nickel if these two went under… Period. Full Stop. Game Over. Like it or not, and as commented on numerous other blogs, we ARE going to end up, ALL OF US, as taxpayers, owners of this debt. Goodbye National Debt. Either way, dollar is toast.
“Fannie and Freddie own or guarantee almost half the 12 Trillion $ mortgage market. If anyone thinks we won’t end up nationalizing these two GSE’s if faced with their demise, they have rocks in their head. The consequence of their demise would be unimaginable, particularly on foreign confidence…”
Stuart, I’m with you. Tells me the FED better think twice before it uses up its reserves backstopping any of the other IB’s.
BTW when the Fed backstops the GSE’s, they’re also backstopping the US real estate market. The GSE’s can’t guarantee foreign real estate, correct?
Just what ultimate underlying assets did the Fed backstop when it committed to the BSC bailout? If one were to drill down into the balance sheet of Bear at the time of its demise, deep enough to drill through all of the structured financial hocus-pocus, what were the fundamental underlying assets that are being protected? Can someone guarantee that they’re also 100% American? Does anyone know?
Would be nice if taxpayers knew the answers to these questions before the next bailout occurs. Might help the government folks to set the right priorities.
Follow up to Anon @12:18
I guess we should take a look at the goodwill created by the BSC crew. That’s really the strategic asset that we, as a nation, couldn’t afford lose. Geez, can’t wait to see what these folks dream up next, now that they’ve been teamed up with JPM. I’ll sleep soundly knowing that taxpayers were able to preserve the remains of such a noble and innovative company.
I want to get this off my chest, again.
I am sick and tired of hearing about the “implicit guarantee” on these things when they are EXPLICITLY not guaranteed.
It’s like nobody has ever actually looked at GSE paper. They have giant disclaimers all over them that say THIS IS NOT GOVERNMENT GUARANTEED.
And the SIV’s and conduits weren’t guaranteed by the sponsor banks, either. But when the____ hit the fan, the assets came back on the balance sheet, Paulson plan or no.
Samuel said…
“I want to get this off my chest, again.
I am sick and tired of hearing about the “implicit guarantee” on these things when they are EXPLICITLY not guaranteed.
It’s like nobody has ever actually looked at GSE paper. They have giant disclaimers all over them that say THIS IS NOT GOVERNMENT GUARANTEED.”
Sheesh.
Samuel, it makes not a whit of difference what the documents say in that regard.
It matters what Bernanke and Congress will actually end up DOING should capitalization levels make things untenable.
Let’s pray the vital players in keeping this thing afloat have more of a clue than you do.
Could we also pray that posters to these blog comments refrain from personal attacks? “have more of a clue than you do”