Treasuries Starting to Look Like Senior Debt of GSEs

As we indicated, a deterioration in Treasuries was the likely outcome of affirming the implied Federal backing of Fannie and Freddie debt. And as we said, we might have been able to persuade our friendly creditors, meaning foreign central banks who also own a lot of Treasuries, that they’d likely be no worse off from a restructuring of GSE debt that involved a modest haircut (or equivalent via a reduction in yield). Too late for that now.

From Bloomberg:

The cost of protecting against losses on Treasuries soared to a record on concern that the U.S. government faces higher liabilities with its support for Fannie Mae and Freddie Mac, credit-default swaps show.

Contracts on U.S. government debt increased 2 basis points to 22 basis points at the close of trading in London, according to CMA Datavision, after earlier reaching as high as 24. The 10- year contracts exceeded a previous record of 20 basis points yesterday. Five-year contracts were unchanged at 16 basis points, according to CMA….

Don’t underestimate the significance of this move. As jck at Alea noted:

In normal times, the spread is less than 2 basis points.

Back to Bloomberg:

“The market is starting to look at the senior debt of the GSEs as approaching full-faith-and-credit obligations of the U.S. government,” said Ken Hackel, managing director of fixed-income strategy at RBS Greenwich Capital in Greenwich, Connecticut. “That is a large book of debt to effectively transfer to the U.S. balance sheet and increase the government’s liability.”

John Jansen gave a longer-form report at Across the Curve. Note the Treasury price deterioration is at the long end of the curve:

Prices of treasury coupon securities posted disparate results today. It was a tale of two markets. The yield on the 2 year note tumbled 6 basis points to 2.39 percent and the yield on the 5 year note dropped 6 basis points also to 3.11. It gets a little less festive in the longer maturities as the yield on the 10 year fell one just basis point to 3.85 percent. The Long bond traded as if it suffered from some dread social disease and the yield on that fabled and storied instrument jumped 3 basis points.Many market participants have cast their verdict on the Bernanke testimony and the judgment is that it was decidedly dovish and lacked teeth regarding inflation. I personally think the bigger problem is keeping the system afloat but if I give the inflation hawks their due headline PPI has been up 1.8 percent in June and 1.4 percent in May. I wonder if the Weimar Republic measured inflation at the core level. That level of inflation can not be comforting to someone holding a 30 year bond with a yield to maturity of less than 4.50 percent.

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  1. Anonymous

    I’m confused as to why there would be a CDS market for Treasury bonds/notes other than to fleece the gullible.

    Treasury debt is denominated in dollars and the govt owns the printing presses that print the dollars. They can alway print as much as they need to make any coupon/principal payment.

    There might be some ‘technical default’ in that the debt ceiling isn’t passed, but the recovery value would surely be close to par.

    Yet another example of why the CDS market is just an upscale three-card monte operation.

  2. Doc Holiday

    Somewhat OT, but with bank failures, there will be bank consolidations and less competition, which is another reason FTC should be involved in this mess — nonetheless — that consolidation will result in lower yields for bank customers and IMHO, less liquidity as more and more sheep are moved into the same pastures, where supply and demand will encounter a liquidity trap, which will be difficult to escape!

  3. Anonymous

    Outside of the two mortgage-finance agencies, credit is getting more expensive and harder to get. The assets of commercial banks fell 5.8 percent annualized in the three months ended June, the second-largest contraction in the 60-year history of the data, according to Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago.

  4. Anonymous

    In its 95-year history, the Fed has never made a clear statement of its policy for dealing with failures. Sometimes it offered assistance to keep the bank or investment bank afloat. Other times it closed the institution. Troubled institutions have no way to know in advance whether they will be saved or strangled. The absence of a clear policy statement increases uncertainty and encourages problem institutions to demand loans and assistance. Large banks ask Congress to pressure the regulators. Taxpayers pay for the mistakes.

    So what can taxpayers expect from an increase in the Fed’s discretionary authority over investment banks? The likely answer is rescues, delays and lax supervision — followed by taxpayer-financed bailouts. Throughout its postwar history, the Fed has responded to the interests of large banks and Congress, not the public.

    Keep the Fed Away From Investment Banks

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