While even moral hazard hawks generally agree that some sort of government intervention would be needed in the event of financial trouble at Fannie and Freddie, the most compelling reason was that the US, chronically dependent on foreign funding, would be ill advised to treat its money sources badly.
Of the GSEs’ $5.2 trillion in debt (their own corporate bonds plus MBS), $1.3 trillion is in the hands of foreign investors and central banks. The speed with which the powers that be cobbled together a support program was seen in some circles as an admission of the importance of reassuring our friendly overseas credit suppliers.
If that was the motivation, it isn’t working. As we and others noted, spreads on GSE debt have risen to 215 basis points over Treasuries, only a tad shy of the pre-Bear crisis level of 238 basis points. And remember, they have reached this stratospheric levels despite the Paulson rescue package, despite an alphabet soup of new Fed facilities that accept GSE paper as collateral (as the discount window did) now in place (although there were raspberries all around for the bailout bill, due to its failure to make any changes in the operation, management, or policies of the GSEs and its lack of specificity as to triggers and what mechanism would be used).
And the reason? A big factor is that foreign central banks are exiting GSE debt and have pulled back significantly from purchases of new paper. This vote of no confidence appears likely to force the Administration’s hand and lead it to take more concrete measures to prop up Freddie’s and Fannie’s balance sheets. They are not about to risk a spike in mortgage rates and further trouble in the housing markets with elections approaching.
An extraordinary Treasury capital infusion may be needed to restore faltering foreign demand for debt issued by Fannie Mae and Freddie Mac, the two top home funding sources that the government is willing to rescue to save the housing market.
The companies rely heavily on overseas investment, often up to two-thirds of each new multibillion-dollar note offering, to help pare funding costs and keep mortgage rates low.
But foreign central banks have dumped nearly $11 billion from their record holdings of this debt in four weeks, to $975 billion, and won’t return in force before it’s clear if — and how — the government will back Fannie and Freddie, some analysts say….
The bonds these companies issue in the $4.5 trillion agency MBS market are near or worse than the weakest levels, set in March before the government engineered the sale of failing Bear Stearns to JPMorgan.
“People are concerned about whether there’s a bailout that’s going to be coming from the U.S., so it would be logical to see foreign investors pull out of agency paper,” said Kevin Chau, forex analyst at IDEAglobal in New York.
“They don’t know whether the U.S. is going to be committed to supporting the GSEs, and if they are going to support them, by what methods are they going to support them.”….
Overseas investors took an atypical back seat in Fannie Mae’s three-year note sale this week.
Central banks bought just 37 percent of the $3.5 billion issue, down from 56 percent in May’s $4 billion offering of the same maturity. Asia accounts took just 22 percent of the notes, down from 42 percent in May….
“Most fixed income investors to whom we have spoken believe that a capital infusion by the government into Freddie and Fannie is a prerequisite for turning sentiment around in mortgage-backed securities and, by extension, in the broader fixed income markets,” Barclays Capital analysts Rajiv Setia and Philip Ling wrote in a report.
A $10 billion to $15 billion infusion for each government-sponsored enterprise (GSE) is seen doing the trick….
As mortgage bonds trade poorly while investors wait for good news on Fannie and Freddie capital, U.S. mortgage rates have climbed to their highest levels in a year.
It took severe measures to restore investor confidence at various times during the year….
In July, the Fed and Treasury agreed to backstop the two companies if needed, and Bush approved the measures as part of a new housing act on July 31.
However, the initial optimism about the plan has been doused by concern about the government’s follow-through… “It would take something dramatic for there to be a material improvement in the confidence necessary to bring foreign investment back to these agencies at the levels we’ve become used to,” [Michael] Woolfolk [senior currency strategist at Bank of New York Mellon] said. “If not the cash injection, then (we need) an overhaul.”
Update 8/18, 10:00 PM: A reader pointed out that the post creates the impression that the 215 basis point spread applies to all GSE debt, meaning GSE guaranteed MBS as well as their own corporate debt. The 215 figure applies only to the MBS, which is more significant from an economic standpoint, since that influences mortgage rates and the amount outstanding is also considerably larger (ie, a price deterioration will have a greater aggregate impact).