Just what is the implicit guarantee on agency debt? Doom North’s trusty 1963 Compact Desk Edition of Webster’s New World Dictionary has
Right.
The DND MILSPEC 7th Concise Oxford helpfully adds virtually contained (in), which sounds more like Bernanke’s fervent prayer than enlightenment. The CO also points at the link with the verb implicate, which is what Mr. Market seems to be about with Congress relative to the guarantee.
A Doom reader informs us that there is presently keen blogosphere interest in this March 15th Congressional testimony,[1] where the Treasury Dept strongly denies that the US stands behind agency debt. Indeed all the GSE paper carries this explicit denial in writing, and the Fed’s Bill Poole is further carrying out a multi-year agitation to quench the market’s expectation that too-big-to-fail doctrine applies to Fannie and Freddie. Still, Mr. Market speaks in a loud and unambiguous voice that implicit means absolute — the proof is in the narrow agency debt spreads over treasuries and the unshakable AAA bond ratings they get from every rater.
The GSEs, for their part, try as hard as they can to pass the risk from their books of business on to other market participants, that is counter-parties. Fannie’s $700-odd billion retained portfolio has got to be the world’s largest pile of off-balance-sheet assets. Who’s bought all this stuff? Doom’s guess is just about everyone.
That’s important to Fannie because these are the guys who are supposed to have taken the lion’s share of the risk from the portfolio’s prime mortgages. Another Doom reader points us at this fascinating market newsletter [2] that MISH has profiled.[3] It seems a lot of the same hedge funds who might be responsible for bits and pieces of Fannie’s portfolio are also having a difficult time handling the fallout from subprime.
I’d especially like to thank the Doom commenters on yesterday’s posts, and the two Doom readers who sent in tips on these topics.
Finally, and a bit off-topic — For Doomers who missed the Jim Cramer advice to homeowners Doom re-posted on July 30th and July 31st, here’s the Reader’s Digest version.[4] This week Kenny’s not just talking to FBs …
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Notes and References
“Testimony of Treasury Under Secretary Robert K. Steel Before the U.S. House Financial Services Committee on Government Sponsored Enterprise Reform”, March 15, 2007.
In addition to ensuring that the new housing GSE regulatory agency has powers and authority consistent with that of other U.S. financial institution regulators, the housing GSEs also have unique characteristics that must be addressed in regulatory reform legislation. The housing GSEs were created to accomplish a mission, and they were provided a certain set of statutory benefits to help in the accomplishment of that mission. For example, in terms of specific benefits the housing GSEs are not subject to state or local taxation and they have access to a line of credit with the Treasury Department ($2.25 billion each for Fannie Mae and Freddie Mac and $4 billion for the FHLBank System, which pales in comparison to the size of their debt obligations). The GSEs also greatly benefit from the market’s perception that the U.S. government guarantees or stands behind GSE obligations, which results in preferential funding rates being provided to the GSEs. On behalf of Treasury, I want to reiterate that the GSEs’ debt and other financial obligations are not backed by the federal government. There are differing views on the precise amount of this benefit, but general agreement that the benefit exists. It is this benefit and a lack of effective market discipline that largely drove the rapid expansion of the retained mortgage portfolios of Fannie Mae and Freddie Mac throughout the 1990s.
[2]: “The Greatest “Bait and Switch” of ALL TIME” (PDF), by J. Kyle Bass, Hayman, July 30, 2007.
[3]: “Busted Bonds & Financial Illusions”, by Michael Shedlock, MISH’s Global Economic Analysis Blog, August 12, 2007.
[4]: “Kenny Rogers – The Gambler”, posted by Henning Christensen, YouTube, June 2, 2007.
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Can someone please explain what the “bank-loan index” mentioned in the Hayman Capital Partners letter, page 3, paragraph 1 is? Also, the letter is dated 07/30/07 and states the index has dropped to 90.5; what is the current number? Thanks, I am continually learning from this blog site and I find I need to Google information all the time when reading these posts, but I can’t find a definition of this particular index.
Igor is giving Bill a hard time
Bill Maloni sends this comment via e-mail [John M.]
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John–Based on dealing with this issue from Fannie Mae’s perspective, as well as my time on the Hill and at the Fed, there just are no specific guidelines for what constitutes an institution that is “too big to fail.”
Each of us can name our own criteria or even identify many large depositories, Wall Street houses, insurance companies, GSEs, or other financial entities, which we think deserve that distinction (remembering that the TBTF concept also applies to commercial entities, which are not financial services companies, i.e. think Lockheed, Chrysler, and Penn Central and New York City)..
But, the plain fact is that TBTF is an “existential term,” meaning that the Fed and Treasury–which would know about a failure far sooner than anyone else–would make a TBTF “call,” only when the institution collapsing is a risk to far more than its shareholders and that its financial demise would cascade problems for the domestic and world markets.
The government agencies then would do a full alert and immediately rush to its aid, providing whatever financial resources, through the bankign system, and soothing statements (more the former than the latter) necessary to keep wholesale panic out of the markets. They would keep doing that until all evidence of wider duress ceases..
Since, one can never know the outcome of an individual business failure–until it happens and the reaction is assessed–you can’t predict with any certainty how the Fed or the Administration in power would respond.
Lastly, a formal reaction also could be delayed, if the market’s initial reaction of “no big deal” changed to “very big deal,” in the days after a failure was publicly known.
Just hope it never comes to any Treasuiry and Fed having to make that call, again.
via e-mail [jm]
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John–One quick caveat. The Fed’s interdiction power is not limited to financial firms, as I wrote, but the action on Chrysler, Penn Central, NYC involved legislation, but the point was that those entities all were deemed TBTF with legislation being the desired route.
Had there been no legislation, one or all could easily have been given the TBTF treatment by the FED/Treasury.