Central Banks Continue Retreat from Alt-AAA Agency Debt

Now we know. The implicit guarantee on Fannie’s and Freddie’s agency debt was "The Safety Net That Never Was" after all.

I would like to personally thank Margaret Kerins and the authors of this Bloomberg article [1] for calling FHFA chief Jim Lockhart out on his Wednesday [note: clearly that should have been "Thursday" -- jm 2/21 2009] testimony to the effect that agency debt was subject to an explicit guarantee from the US Treasury.

The comments are Lockhart’s strongest yet in his efforts to combat doubts by investors about his commitment and that of Treasury Secretary Henry Paulson in standing behind the debt. The extra yield investors demand to own Fannie and Freddie corporate debt versus U.S. Treasuries fell today after his comments.

“It’s a clear move by the government to try to verbally reinforce the relationships with the government without taking any other action,” Margaret Kerins, managing director of agency debt strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut, said. “I think at some point the market will see through that, and force Paulson to say something, or fade it.”
…

“Up until this week, we haven’t heard Lockhart say `explicit’ before and we certainly haven’t heard Paulson say `explicit,”’ Kerins said. “They’re trying to put the GSEs back on par with where this FDIC-backed paper is coming.”

“Nothing has changed though,” she added.

Well, everything changed after Lockhart’s testimony hit Wall Street. We’ll never know if it was the startling clarity of the Bloomberg article or some blistering memo coming down the pipe from Treasury to FHFA, but Lockhart immediately published a clarification [2] that put everything in the sharpest perspective. The Explicit Guarantee the markets drew from Lockhart’s testimony was immediately switched to an Effective Guarantee backed by an Explicit Commitment from the Treasury worth up to $200 billion. One flick of the wrist in today’s shell game replaced the Full Faith and Credit of the US with some mad Alternative to AAA limited Treasury support, hence my new characterization of agency debt as being equivalent to Alt-AAA.

 

UPDATE: Looks like the "Effective" in the new guarantee isn’t going to be very effective.  My apologies for not finding the original June post, but this blog article quotes Nouriel Roubini as saying: "… we estimated in June that the eventual losses for the government from this bailout could be as high as $200 to $300 billion, an estimate that is now shared by former Fed Governor William Poole."  If the Good Doctor is right about that estimate, the Treasury’s $200 billion limit is already barely enough to possibly cover the existing damage.  Any additional losses arising out of having Fannie and Freddie buy further suspect paper will then flow right to the GSE bondholders.

 

The MSM was in considerable confusion [3] over this story as the day progressed. Bloomberg reposted [4] their earlier story, but in doing so changed the word "Explicit" in the headline to "Effective," which had the effect of preserving both versions in the wild. Significantly, Ms Kerins’ comments were spiked in the second version.  Here’s some of what Google News saw yesterday:

 

 

Meanwhile, back at the ranch, our trusty weekly Reuters report on central bank buying trends [5] included a nice analysis of where a lot of the pressure that influenced the above Foofah (if you’ll pardon the expression ;) ) was coming from.

A federal measure to guarantee short-term bonds issued by banks has been perceived as putting them on a higher credit standing than securities issued by from [sic] mortgage agencies Fannie Mae, Freddie Mac and the Federal Home Loan Bank System.

 

The Reuters report comes from FRBNY’s weekly statistical release H.4.1 [6] and Doom has again added the last week’s data to our CSV file going back to early 2000.[7]

Reuters reports a net buy of $12.57 billion treasuries and a net selloff of $8.28 billion agencies, for a healthy total net buy of US obligations of $4.29 billion. Those are both large moves, but much smaller than those in the previous two weeks (and not enough to crack either of Doom’s Top 10 lists). The basic trend towards treasuries and away from agencies continues, as is obvious in the raw numbers graph.

Obviously the agencies sell-off moderated considerably last week, but the trend is still to convert these to "no risk" treasury debt.

Last week’s move was not in the top ten.

However, if I recall correctly, it would be in about 4th or 5th place for sell moves.

The treasuries buy trend moderated quite a bit, too, and this week’s buy also failed to make the top ten.

However, the diversion caught in the ratio graphs continues unabated.

________________________

Notes and References

[1]: "Fannie, Freddie Have `Explicit Guarantee,’ FHFA Says (Update3)", by Dawn Kopecki and Jody Shenn, Bloomberg — Last Updated: October 23, 2008 12:36 EDT

[2]: "***MEDIA ADVISORY**** CLARIFICATION TO TESTIMONY", FHFA, October 23, 2008.

To clarify the last paragraph of page 3 of Director Lockhart’s testimony, the testimony should read: “The conservatorship and the access to credit from the U.S. Treasury provide an effective guarantee to existing and future debt holders of Fannie Mae and Freddie Mac as there is an explicit commitment by the U.S. Treasury to provide up to $100 billion in senior preferred stock for each Enterprise.”

 

[3]: "Lockhart’s Fannie, Freddie Guarantee Remarks Stir Up Confusion", by Dawn Kopecki, Bloomberg, October 23, 2008.

[4]: "Fannie, Freddie Have `Effective’ Guarantee, FHFA Says (Update1)", by Dawn Kopecki, Bloomberg — Last Updated: October 23, 2008 14:06 EDT

[5]: "Foreign central banks’ agency holdings fall – Fed", Reuters, October 23, 2008.

[6]: "H.4.1 Factors Affecting Reserve Balances", Federal Reserve Statistical Release (weekly), Federal Reserve Bank of New York.

[7]: The updated data set as a Comma Separated Value (CSV) file is here.

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7 Comments for this entry

  1. John M. says:
    October 24, 2008 at 7:37 AM

    This may be the most explicit declaration for the $200 billion max Treasury cap on Agency Debt support to come out of yesterday’s festivities:

    “Regulator: GSE debt does not carry full faith, credit”, Reuters, October 24, 2008.

    “It is not a full faith and credit,” James Lockhart, the director of the Federal Housing Finance Agency, told the Senate Banking Committee.

    “It is an effective guarantee because there is a $100 billion backing their equity provided by the U.S. Treasury that does give them, effectively, a guarantee of the U.S. government.”

    Effectively my @^%$$

    With Roubini’s estimate for the damage already above the cap, there’s almost no way a haircut for the bondholders isn’t already baked into the pie.

  2. John M. says:
    October 24, 2008 at 7:58 AM

    SA provides some quotes from WSJ’s aptly titled subscription article “Words Vex Mortgage Investors”.

    “Wall Street Breakfast: Must-Know News”, by Rachael Granby, SeekingAlpha, October 24, 2008.

    Confusion on Fannie/Freddie debt. Risk premiums on debt securities from Fannie Mae and Freddie Mac reversed course, first tightening up to 0.07% and then widening by 0.02%, on confusion about the government’s guarantee of these bonds. Federal Housing Finance Agency [FHFA] Director James Lockhart had said the government’s seizure of Fannie Mae and Freddie Mac represents “explicit” support for the companies’ debt and mortgage-backed securities, but FHFA later distanced itself from those comments and said debtholders have only an “effective” guarantee. The practical difference between Lockhart’s “explicit” and FHFA’s “effective” remains unclear to investors, nor is it known whether Lockhart’s language reflects a forthcoming policy change.

  3. John M. says:
    October 24, 2008 at 8:14 AM

    Doomers should click on the link and read this whole article. There’s lots more good stuff besides the sample I’m quoting.

    “Taiwan Dumps Fannie, Freddie. And Uncle Sam? Despite bailout, GSE debt is eschewed by major foreign investor, and ally”, by Randall W. Forsyth, Forbes, October 24, 2008.

    Now Washington might well worry about who lost Taiwan as a major investor in U.S. agency securities as the Republic of China has openly questioned their credit quality — even after the federal government has committed hundreds of billions of dollars to bail out mortgage giants Fannie Mae and Freddie Mac.

    Beyond that, Washington might well worry that other nations also no longer view its agencies — and now, by extension, the very credit of the United States of America — beyond question.
    …

    In either case, the Taiwanese action is a blow to the reeling U.S. mortgage market, which has been supported by the Republic of China’s purchases of agency securities. According to U.S. Treasury data, Taiwan owned a very substantial $55 billion of U.S. agencies along with $43 billion of Treasuries as of June 30, 2007, the most recent date for which these data are available.
    …

    Despite those actions to prop up the GSEs, yields on Fannie and Freddie debt securities have continued to rise to record spreads over Treasuries. Two-year Fannie notes were yielding almost 140 basis points (1.40 percentage points) over Treasuries while 10-year Freddie notes traded 95 basis points over the corresponding Treasury note. Those extraordinary yield premiums for what are, de facto, U.S. government obligations.

  4. Idaho_Spud says:
    October 24, 2008 at 9:22 AM

    http://www.asianinvestor.net/article.aspx?CIaNID=87297

    Yup John, same news you posted in the comment just above. Taiwan is done investing in mortgage debt. Took ‘em a while to see the light, didn’t it? ;)

  5. John M. says:
    October 24, 2008 at 10:05 AM

    Spud -

    Thanks for dropping by :)

    If other Asian Tigers decide to follow Taipei, it’s not obvious who’s going to buy the stuff. I’m especially worried about Mohamed El-Erian and his good buddy Bill Gross. This from the Barron’s article (#3 above): “$130 billion Pimco Total Return Bond fund … boosted its holdings of MBS (primarily Fannies and Freddies) to 79% by the end of September. That was the highest since June 2000 and an increase from 69% at the end of September.” [obviously wrong, I think it's MoM from end of August -- OK, on second thought Sept '07? YoY? (one month awfully short for that big a move, I just don't know)]

    Looks like those guys are full up. Perhaps Kashkari will need to buy a lot of conforming US mortgages in the near future to bail out Hank’s buddy Bill. Who else would be able to?

  6. John M. says:
    October 24, 2008 at 4:14 PM

    Doom’s old friend Paul has weighed in with a conservative interpretation:

    “Lockhart’s Remarks Confuse GSE Debt, MBS Investors”, by Paul Jackson, HousingWire, Oct 24, 2008.

    Friday morning, investors were still grappling with Lockhart’s choice of words, and asking: what’s the difference between an effective and an explicit guarantee? The difference probably is as simple as degrees — an effective guarantee being one degree away from direct government funding. [emphasis in original this time]

  7. John M. says:
    October 27, 2008 at 2:41 PM

    Reverberations of the “Effective Guarantee” continue.

    “Fannie, Freddie Mortgage-Bond Spreads Hit Widest Since March”, by Jody Shenn, Bloomberg, October 27, 2008.

    The increase in mortgage-bond spreads has come as the debt costs for Fannie and McLean, Virginia-based Freddie, the largest holders of their own securities, again rose to records last week after the companies’ regulator sowed confusion over their level of federal support.
    …

    Foreign central-bank holdings of agency debt and agency mortgage bonds dropped $47 billion over four weeks to $923.4 billion in the week ended Oct. 22, Federal Reserve data show. The holdings are down from a record $983.9 billion on July 16.

    “People have developed a lot more of their own problems in the last six weeks, than they had three months ago,” RiverSource’s Jackson said in a telephone interview. “Countries, really just like banks, need to hold liquidity to prop up their own financial well-being and they’re not going to lend that out to other people.”
    …

    When taking Fannie and Freddie over, Treasury Secretary Henry Paulson said he would direct the companies to increase their $1.5 trillion mortgage-asset portfolios and have his department start buying their home-loan bonds to help lower the cost of home financing.

    ——————————
    a bit later … WireGuy has weighed in on this:

    “Problems Pile Up in Agency MBS Market”, by Paul Jackson, HousingWire, October 27, 2008.

    For those in the primary mortgage markets, such widening spreads usually portends higher mortgage rates for borrowers — although in this market, just about anything that used to hold true about the mortgage market has pretty much been turned on its head.
    …

    Market imbalances notwithstanding, HW’s sources have been far more concerned lately about a separate development: the dearth of overseas buyers for agency MBS in recent weeks. Foreign central-bank holdings of agency debt and agency mortgage bonds fell $47 billion to $923.4 billion in the four weeks ended Oct. 22, according to data released by the Federal Reserve; more than a few media reports have suggested in recent weeks that the flight of foreign money out of the agency MBS market reflected some fundamental concern over credit.

    Not so, according to many of HW’s sources. Instead, we were told, at issue is liquidity and a crisis that has now expanded well beyond U.S. borders — foreign governments, much like any private corporation, are looking to put themselves into the most liquid position possible to ensure they can bail out their own banks, we’re told. And, sort of in an unintended consequences sort of way, the U.S. government’s own actions to bail out the banking sector have made agency MBS less liquid than other potential investments.

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