Fannie, Freddie Sale Goes Well

Bloomberg reports that today’s sale of $3 billion of GSE debt went well, which investors took as a sign that a GSE crisis is not imminent.

However, even this striving-to-be-upbeat article had some threads that bode ill for the longer term. And DealBreaker pointed out earlier this week that there is a profitable arbitrage on offer between Freddiedebt and the Term Auction Facility. A cynic might wonder how much support that factor is offering to these sales.

From Bloomberg:

Fannie Mae and Freddie Mac sold $3 billion of short-term notes at yields that suggest the U.S. mortgage-finance companies are still capable of financing their businesses without government assistance….. Today’s spreads were wide enough to attract demand, yet narrow enough to dim speculation that the government-sponsored enterprises will be forced to turn to Treasury Secretary Henry Paulson for support…..

Merrill Lynch & Co. analysts Kenneth Bruce and Cyrus Lowe today said a bailout of Fannie and Freddie is “premature” because losses won’t cause capital to deplete for several quarters.

Yves here. While Fannie and Freddie debt is mainly short-term, a forecast that “there is enough capital for a few quarters” is far from reassurning. Back to Bloomberg:

Moody’s Investors Service and Standard & Poor’s this month affirmed the top ratings on the $1.5 trillion in senior debt for Fannie and Freddie, citing the likelihood that the Treasury would make sure those bondholders are protected.

So the ratings presume the implicit guarantee is now explicit. Thus the ratings agencies have taken the question of the firms’ own capital adequacy off the table.

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  1. Anonymous

    FYI: The yield on a ten year bond at almost a 30 year low: "Ten-year Treasury yields have fallen the furthest below the inflation rate in 28 years. The Consumer Price Index climbed 5.6 percent in the year ended in July, the Labor Department said Aug. 14. The so-called real yield is now a negative 1.80 percentage points.'…nWVs& refer=home

    An onslaught of new bonds — around $80 billion to $100 billion — is expected to hit the market in September.

    The Treasury Department is scheduled to auction $32 billion of two-year notes tomorrow and $22 billion of five-year securities on Aug. 28. The size of the two-year sale is a record, and the five-year auction will be the biggest since February 2003.

    “How much of this is going to wind up on dealers' shelves?'' said George Adell, a fixed-income strategist at Philadelphia-based Commerce Capital Markets. “The Street is starting to build in a concession to sell these offerings.''

    A concession occurs when traders sell government securities prior to an auction, driving yields higher and making the soon- to-be-sold issues more attractive.

  2. fred

    A closer read of Merrill note shows that notwithstanding the bloomberg quote, Merrill think FNM WILL NOT FALL BELOW STATUTORY MINIMUM AT ALL. They don’t just think FNM will make it through the next few quarters, they believe, as do Lehman, Fox Pitt, and Citi, that FNM will not fall below minimum capital requirements at any point.

    Merrill’s “base case” has captial hitting a trough in 2010 with $5.4 billion of EXCESS capital, down from $12 billion at end of 08.

    It is important to understand that FNM is generating something like $10 or $11 billion per year in income before credit expenses. That means they can lose $10 or $11 billion every year without eating at all into the capital on the balance sheet. People who say FNM is going to lose $50 billion so they will be wiped out miss the fact that the $50 billion cannot all occur in 1 yr. They can lose $50 billion over 5 yrs without any hit to capital at all.

    FNM and FRE together can lose $100 billion over 5 yrs and still not violate minimum capital requirements.

    This is why it is not crazy to say they don’t need to do an equity issuance to raise capital. They generate the capital they need internally.

  3. Anonymous

    Re: minimum capital requirements.

    As you recall that 30% requirement was just lifted without justification!

  4. AlleyGator

    So the ratings presume the implicit guarantee is now explicit. Thus the ratings agencies have take the question of the firms’ own capital adequacy off the table.

    Yves, how can the Treasury’s request–and the Congress’s approval–to backstop the GSE’s ever, ever be interpreted to mean that their senior debts will go unpaid?

    The GSE’s may be getting bent over a barrel right now, but the barrel has an $800 billion dollar line of credit in it.

  5. Anonymous

    Without that guarantee, both could quite conceivably default before GM. What’s GM’s rating again?

  6. mdubuque

    I was reading where some players are arbitraging these new Freddie securities by immediately pledging them as collateral at the Fed’s primary dealer credit facility and locking in the gains.

    Please forgive me for not posting the link. I should have saved it. It was from a highly reputable source (I thought it was from the blog from the Atlanta Fed, but apparently not…)

    Matt Dubuque

  7. Yves Smith


    The link is in the post. It’s the DealBreaker piece mention.


    The reason for bringing up the rating agencies is their ratings no longer reflect the GSE’s stand-alone finances (they probably never did), but assume the government guarantee is in place. Thus they can’t be used to argue “no bailout is necessary.”

    In general.

    The statutory minimums for Freddie and Fannie are far below those that would be acceptable for an AAA rating for a private entity. As we (and economists like Jim Hamilton) have said repeatedly, the GSE’s capital bases are insufficient if they are stand-alone risks. They aren’t even remotely AAA, and fulfilling their Federal charter requires them to fund at good prices. But the GSEs now can’t sell needed equity because of the risk that a bailout would wipe out or impair the rights of common shareholders.

    And as we have noted, the analyses that “the GSEs will be OK” focus on credit risk. The estimates even on this issue are all over the map, no doubt reflecting the opaqueness.

    These analyses also do not appear to consider the mismatch/derivatives risk, which has led to substantial losses in the past.

  8. Yves Smith


    If I were to apply Barry Ritholtz’s standards for comments, which we generally hew to here, yours would have been deleted. Your angry tone suggests you have a vested interest in defending the GSEs. If you cannot address me in a civil manner, I will remove all your comments.

    One, as has been stated repeatedly in comments, the standing of the guarantee was a topic of considerable debate until recently.

    Second, the GSE’s capital bases, as Jim Hamilton noted in his Jackson Hole presentation in 2007, is far too low on a stand-alone basis to warrant the tight spreads over Treasuries they then commanded. The market presupposed the government guarantee even thought the offering documents disavowed them.

    Chris Whalen, who runs the highly respected firm Institutional Risk Analytics, which analyzes banks in excruciating detail, noted in July:

    The GSEs were to the US economy what special purpose entities were to firms like Enron, Parmalat and Citigroup (NYSE:C). Bloated far beyond their historical role of merely acting as conduits for securitization of residential mortgages, FRE and and FNM operate at much higher leverage ratios than any bank or hedge fund and now have three basic business lines:

    * A conduit for buying and securitizing qualifying mortgages as per federal housing law,

    * An insurance unit that guarantees mortgage-backed securities, also in support of the housing mission; and

    * A fixed income hedge fund operated for the benefit of FNM’s and FRE’s managers and private shareholders….

    A 2001 study by the GAO suggested that the GSEs might warrant a “A” rating as private stand alone entities, but we’d argue for closer to “BB” based on the leverage of FRE and FNM.

    I suggest you write Whalen if you disagree with him:

    Both Whalen and John Dizard of the Financial Times, who has strong, long-standing connection in the fixed income and among central bank staffers, both say that in fact the GSEs are taking considerable risks (Whalen’s hedge fund comment). Dizard specifically says in their derivatives books. Per his latest FT article:

    First, Fannie Mae and Freddie Mac need to be nationalised…

    Most of the discussion of the need for a federal takeover of the GSEs has concerned their credit losses on subprime and Alt-A paper. However, even if a private recapitalisation could be done to offset those, the GSEs would not have sufficient capital to handle the long-term risk of the maturity mismatches on their highly leveraged balance sheet.

    Let’s say there’s a great economic recovery, housing prices stabilise, and the interest rate curve becomes more normal. The rise in long-term rates would lead to an extension of the maturity of mortgage portfolios, which would need to be offset by hedging activities. Significant declines in the long end would also need to be hedged, as homeowners refinanced. I don’t believe the interest rate swaps market will have the capacity or willingness to take on that risk at any payable price. One way or another, these institutions will spend a considerable time with negative equity. Again. The only way to handle that is with government ownership.

    They both seem to differ with your contention that the duration is (or perhaps can be, given the elephant in the bathtub problem they have) as tightly matched as you say. Before the GSEs were front burner, Dizard had discussed, more than, once, that the Fed had been worried in 2002-2003 that the GSE’s hedging was creating systemic risk.

    If you have a problem with this line of thinking, I suggest you take it up with Dizard, particularly since his readership is much larger than mine.

  9. Stuart

    and why shouldn’t it go well with people believing that the Treasury is backstopping the debt. Higher yields than treasuries, no perceived risk… Wall st would love this.

  10. Anonymous

    “It shows market participants’ desire to lock in term financing … well ahead of time, notwithstanding the likelihood that the central banks will in the end do whatever it takes to prevent a huge rise in year-end financing costs.”

    One surprise in recent weeks has been the widening of six-month Libor/OIS spreads in dollars and euros to historic maximums of 105 and 85 basis points respectively.

    Before August last year, these spreads typically hovered around 10 and five basis points.

    Anticipated three-month Libor/OIS spreads starting in December — so called three-month forward spreads — have also ballooned since the start of August.

    Three-month forward dollar spreads have widened to 93 basis points from 72 basis points; euro spreads to 81 basis points from 67 basis points; and sterling spreads to 100 basis points from 73 basis points, according to Morgan Stanley data.


    Demand for funds at year-end is perfectly normal. But acquiring this cash is now an acute problem because banks have been reluctant to lend to each other since the U.S. sub-prime crisis began to threaten the sector.

  11. Yves Smith

    I do not like deleting comments, but after providing a warning, and referring to Barry Ritholtz to show our practices are hardly unusual, Fred chose to escalate the argument.

    Barry tells me he deleted 20 comments (and I believe he meant IP addresses, since he blocks those as well) on a single recent post. By contrast, this is the 9th non-span comment removal in the 21 months this blog has been up.

  12. gordon

    I don’t have a dog in this fight and only read this blog to see a wider range of views than is allowed in major newspapers – an unbiased and unvarnished range of opinions, not only those that have escaped the letter editor’s censure.

    So whether or not you did not like Fred’s opinion or tone there was nothing offensive in it. Therefore I was exceedingly upset by your comment that you considered deleting it. If that is the attitude, what else is deleted ? How can I now believe that this is an open forum, and not just a me too posting site where those that don’t agree are deleted.

    Very disappointing.

  13. Anonymous

    Moody's Investors Service and Standard & Poor's ratings are partly responsible for this mess, why does anyone care what they say anymore?

  14. Yves Smith


    One, all deletions are visible, as you can see.

    Two, Fred’s tone was hectoring. I have the post locally and it is objectionable. The hostility may not have been evident to you, not being on the receiving end.

    Third, you probably did not see Fred’s reply. He clearly had not read the links I provided and chose to escalate the fight rather than deal with the issues.

    Fourth, it appears neither you nor he have clicked on the link to Barry’s comment standards. I suggest you have a look.

    I put a tremendous amount of time into this blog. I do not make even minimum wage from it. Barry, who has far more experience than I do, strongly advocates weeding out comments from people who are aggressively unappreciative.

    I don’t mind differences of opinion, If you read any of the past threads here, you will see there are plenty of opposing views and they are often very educational for me. I have little tolerance, however, for people who launch into me.

  15. doc holiday


    Hussman Sees Trouble Ahead

    Years ago, Larry Williams used to look for a situation he called the “Jaws of Death”—noting that when bond prices were weakening but stock prices were strengthening, the two differing trends opened a set of “jaws” that tended to snap shut, usually due to abrupt weakness in stocks.

    He points to expectations for lower volatility in the stock market (measured by the VIX index) at a time when credit markets are getting more worried. See the chart below:

    Those jaws could be setting markets up for a tough reckoning. Let’s give Hussman the last word:

    In short, the markets are presently trading on a theme that largely overlooks the potential (and in my view, the reality) of a significant U.S. recession. At the point of recognition, we may very well observe abrupt weakness in both stock prices and the U.S. dollar.

  16. esb

    Richard Milhous Nixon was a brilliant man with “little tolerance, however, for people who launch into” him. That intrinsic trait was the source of the undoing of his administration.

    It has always frightened me when those who fear dissent and crave appreciation (genuflection?) find themselves in positions of authority, which the chokepoints on the free flow of ideas truly are.

    The couragous character meets dissent, falsehoods and rudeness with argument and fact, not force.

    God knows we have seen quite enough of the opposite during the past seven+ years.

  17. Anonymous

    Yves we did have a chance to see Fred’s response before you deleted . It did not escalate the argument it asked some valid questions about what you thought was so offensive about the first post. You are overly sensitive at the expense of your readers.

    Ritholz encourages dissent, you are using his rules to stifle someone who is challenging you

  18. foster

    9 posts in 21 months is not Nixonian. You guys act as if this is your blog, It isn’t.

    I read the first of Fred’s two removed comments and I recall thinking he was goading for a fight. If I can remember that as a reader, this isn’t Yves’ imagination. He may not have used words like ‘idiot” but the intent was clear.

    There is a lot of dissent here. If you choose to get all worked up about one incident, I’d say you are the ones who are hypersensitive.

  19. Anonymous

    Fred’s tone was about the same as Yves and many commenters routinely use in referring to government officials, company executives, and various other third parties.

    The bigger point is Fred’s post had meaningful content whose value to readers should have outweighed the blow to Yves ego.

    It’s Yves blog, of course he can edit as he sees fit. that doesn’t mean whatever he does is good for his readers

  20. Anonymous

    Unless you stay at The Big Picture and hit the refresh button all day, you cannot say with any confidence what Barry does. I did look at his policy. He reserves the right to be arbitrary and bans IP addresses permanently.

    And this “courageous character” stuff does not work with people are vested in their point of view. It’s easy to see with trolls, but there people who are more sophisticated who ask questions not to get to the truth but to prove that they are right and the other person is wrong. Dealing with them is like fighting with a tar baby.

  21. Anonymous

    This thread looks suspicious to me. The last time Yves ran somebody off, and that was months ago, he had good content but completely one sided and over time annoying, Even I started finding him a bit much.

    Bottom line: as I recall, comments then were generally supportive of Yves, I don’t recall any “quashing of dissent” chest-pounding or high-toned moralizing among the dissenters.

    Here we have a rash of comments supporting Fred and claiming they saw a post that was barely up. Betcha most if not all of these comments are from Fred.

    Yves, did you forget to block his IP address? Or were you giving him a chance to shape up after being slapped around? Or am I paranoid?

  22. Anonymous

    There are trolls whose sole purpose is to make blogging unfun for those they dislike, both writers and readers, but especially writers. Imagine an untrained detective force, mostly unpaid, but free to work on whatever they choose, whenever they want to work. What this force loses in efficiency it might make up for in sheer numbers. Especially if it looked like fun.

    Don’t let this bother you, Yves. Fake anonymous comments are as cheap as the souls of those who write them, and such should not bother those who try to speak truth.

  23. Reprobate

    ROTFLOL! What delicate sensibilities! Deleting a couple of comments is compared to Nixon and Bushco, and tolerating backchat “courageous”? Gee, can we bring in Joe McCarthy, Attila the Hun, and Nelson Mandela while we are at it?

    Someone has an exaggerated sense of his self-importance.

  24. Anonymous

    anon 9:14, the other guy Yves ran off was calling BS on what Yves was saying about MBIA. That guy was completely right.

  25. Anonymous

    doc holliday – what evidence do you see of bond prices weakening? If i look at TLT it appears as though Treasuries (at least) are strengthening. What metric describes the bond weakness to which you refer? Are we in a situation where bonds are weakening and Treasuries are strengthening?

    My apology is this is a dumb question.


  26. brinkman

    10:46, what are you talking about? Yves has been right about MBIA.

    There is no meaningful muni guarantee business left for them between the deterioration in the credits, the push from Congress that ends the overly-low ratings that allowed for the low/no risk ratings arbitrage, and competition from Berkshire, which has an uncontested AAA. The structured credit business by all accounts isn’t coming back anytime soon, and even if they figured out a way to write it, the stock market probably would not like it. They may not be dead yet, but there isn’t any good reason to be optimistic about their future.

    Why would MBIA’s own regulator try to organize a rescue if there wasn’t a problem? Regulatory capture is the norm. If a company can’t persuade its primary regulator, who can see inside records in confidence, that they are OK, I take that as prima facie evidence that there IS something amiss.

    His first skeptical post was August 2007. The stock was over $60 then. It’s $12 today.

  27. Anonymous

    brink, I have no desire to get into a debate over MBI with you or Yves, but check tonight’s news as to whether the regulator is confident MBIA is ok.

    Anyway, when Yves chased that guy off the guy was saying correctly that Yves was completely wrong about MBIs GIC business. This was just within the last couple of months and the stock is way up since then. Whether Yves was right or not prior to that, he was wrong on this particular issue and he chased off a guy who clearly understood the company better than Yves and could have contributed to readers understanding.

  28. brinkman

    Whoops, sorry about that.

    MBIA and GICs is pretty specific. I went and looked at the blog, it was the second one that came up.

    I can only see one side, but it is pretty clear that Yves was correcting the post. went to some lengths to be polite, and the guy kept being rude. Multiple apparently rude comments in succession. Others found him rude too.

    The attacks were ad hominem. No one has to put up with that. Maybe you think it’s OK to yell at customer service reps and waiters, but I think that sort of behavior is out of line too. If you are citing that as an example of Yves being off base, you’ve actually made his case, not yours.

  29. Michael

    I have been reading this blog for a year. I didn’t catch Fred’s comments but I have, over time, built up respect for Yves efforts and responses in the comments section. I also haven’t seen any comment blocking until today. I am more than willing to give the benefit of the doubt.

  30. doc holiday

    Gorg @ 10:57

    This is an interesting sequence here and unusual today/tonight!

    Re: I don't follow TLT and although it may have been around a few years, it has very little cash in it, so not sure I would consider this a barometer to sail with. Nonetheless, you can see this year that it acts like any bond, in that its price has gone up during times of stress and thus the yield goes down.

    My interest is the 10 year Treasury which is at 3.77% and as I posted, that is almost a 30 year low in yield. I also watch the P/E of S&P 500 and thus the earnings yield there which should be dropping, but….

    Even with all the disasters in the sector, for 2007, the Financials accounted for 21.8% of the total net income for the S&P 500. In 2008, that is currently expected to decline to 8.6% before rebounding to 17.2% in 2009. However, in recent years the sector has accounted for well over a quarter of all earnings.

    The S&P 500 as a whole is trading for 15.2x and 12.1x, 2008 and 2009 earnings, respectively. Based on a blend of 50% 2008 earnings and 50% 2009 earnings, that translates to a 7.32% earnings yield, which looks extremely cheap relative to a 3.87% ten year T-note. Even against the A rated corporate bond yield of 6.20% it looks attractive. However, the current level of expectations for corporate earnings still implies that profits will stay well above their historical averages as a share of GDP. That would be an exceedingly rare occurrence during a recession. The comparison between the earnings yield on the S&P and the 10 year T-note is in my opinion more a reflection of the extreme unattractiveness of long term T-notes at this point than stocks looking particularly cheap in general, however there are attractive stocks out there.

    It appears that the flight to quality has caused a massive bubble in the price of T-notes. This is far and away, in my opinion, the most significant bubble in the market today, not the price of oil. The prices are hard to justify given the risk that the massive injections of liquidity by the Fed to ameliorate the credit crunch will end up fueling the fires of inflation.

  31. doc holiday

    Ihave to toss this video in for Yves:

    This blog has turned into a hortafest!

    This episode is the source of the exclamation “I’m a doctor not a bricklayer!”, uttered by Bones when Kirk orders him to attend to the injured Horta. McCoy successfully uses cement mortar as dressing for the Horta’s wound.


  32. Spectator

    Someone’s awful anxious to dress up the GSEs, those disastrous scams that enabled theft at a massive scale. Should not surprise any of us that they’ve started an effort to shape opinions in blogs. The blogs need to be silenced – they reveal the truth the media refuses to see until too late.

    Yves is right to remove these overbearing attempts to put lipstick on these pigs and hide the truth.

  33. Anonymous

    Spectator, apparently you only want to hear views that comport with your own. It is not as though Yves is speaking truth to power about the GSEs. NY Times, WSJ, and all the press are filled almost daily with predictions of imminent bailout and disastrous losses. Its ironic that you suggest someone is trying to silence the blogs when, as Yves has show, the bloggers exert absolute power over their domain. Who was silenced in this instance?

Comments are closed.