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.
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.