"You mean to tell me that the coins being stamped out at the Mint are, the very same night, melted down into bullion on Threadneedle Street?" [1]
Yesterday, Doomer NVmike asked: "John, can you explain, in simple terms, the differences between “Agency” and “Treasury” debt?" This post is an attempt at a response. The plan is to start off simply, and then go off on a rant. There’s more here than meets the eye, and some of the issues are critical.
Doomer Yossarian’s reply to NVmike’s query is a good place to start. It points to this rather dated (Sallie Mae has been privatized) summary of the Treasury and Federal Agency securities markets. A Government Sponsored Enterprise (GSE) is a company that has been granted a government charter to perform some socially useful purpose, and has therefore been given certain powers and privileges to carry out those purposes. Agency Debt is the senior debt (that is, bonds issued by) a GSE. Many but not all GSEs are financial services companies. The Tennessee Vallue Authority (TVA), was about the first GSE, and it’s a power utility.
The charters and privileges of GSEs differ as to the amount of support their bonds get. As of August 2008, it was obvious that Ginnie Mae’s Agency Debt was more explicitly guaranteed than were Fannie’s and Freddie’s.[2] However, all Agency Debt is supposed to have at least strong backing from Washington. I don’t think a US agency bond has ever defaulted, but the Agency Debt issued by Fannie, Freddie, etc. consists of Mortgage Backed Securities (MBS) and there has been concern about default risk as house prices plummet and homeowners go into default. Officials have been giving agencies ambiguous support lately, which has spooked some investors.
According to this page of the Treasury Dept site, "Treasury bills, like other marketable Treasury securities, are debt obligations of the U.S. Government and are backed by the Government’s full faith and credit. A bill is a short-term investment issued for a year or less." This makes Treasury Debt the safest, constitutionally protected, debt the government has to offer. Often said to be "risk free."
"I understand. But it sounds like a scheme to make something out of nothing–a perpetual motion machine. Somewhere, somehow, in some unfathomable way, it must have repercussions."
"Quite possibly," said Pontchartrain, "but I cannot make out where and how exactly. You must understand, the King has asked me to double his revenues to pay for the war. Double! The usual taxes and tariffs have already been squeezed dry. I must resort to novel measures." [3]
Foreign central banks have lately demonstrated that they appreciate the subtle distinction between Treasury Debt (risk free) and Agency Debt (Oh God, oh God, we’re all going to die?):
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Thanks again to twist for that marvelous extension of Setser’s chart she got up on very short notice Tuesday evening. The discontinuity was touched off in mid-July 2008 when the markets realized that Fannie Mae and Freddie Mac might eventually have to consolidate their off-balance-sheet vehicles (Fannie calls them QSPEs) and recognize the need for more risk-based capital. Under pressure from the implied threat to their debt, officials first seemed to offer an explicit government guarantee (Jim Lockhart) which within hours degenerated into the farce of an "effective" guarantee ambiguously capped at $200 billion (to start). The waters are still terribly muddied on that one, and cenbanks’ confidence is obviously shot.
"But, Daniel, that never happens. Mrs. Bligh, if she wants coffeebeans, can go down to the docks and shew her book–or her Lectern, in a pinch–to a merchant and say, ‘Behold, every powerful man in London is in debt to me, I have collateral, lend me a ton of Mocha and you’ll never be sorry!’"
"Roger, what is Mrs. Bligh’s bloody book–by your leave, Mrs. Bligh!–but squiggles of ink? I have ink, Roger, a firkin of it, and can molest a goose to obtain quills, and make ink-squiggles all night and all day. But they are just forms on a page. What does it say of us that our commerce is built ‘pon forms and figments while that of Spain is built ‘pon silver?"
"Some would say it speaks to our advancement." [4]
Now here’s the punch-line of the joke.[5] It came out just the other day that the Fed has hired four companies to sell it half a trillion dollars worth of MBS over the next 6 months. Most of that paper will be agencies. And what is it buying that stuff with? The half-trillion dollars net buy of treasuries over the last 52 weeks represented by the tip of the yellow line in twist’s chart above. Now you should be able to see the point of the quote at the head of this post. What we’ve got here is a tight little circle. A short circuit going pfzzzt! There’s really no difference between the two types of paper at all.
UPDATE (May 9, 2009): I’m presently about half-way through Neil’s new (and relatively slow-paced) philosophical fantasy. It’s had its moments.
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[1]: Stephenson, Neal. Quicksilver. New York: Harper Collins, 2003. p. 211.
[2]: "How Ginnie Mae differs from Fannie, Freddie", by Kathleen Pender, San Francisco Chronicle, August 5, 2008.
Ginnie Mae-insured bonds have always had the explicit backing of the federal government.
Fannie and Freddie guarantee bonds backed by mortgages that have no government guarantee. Although Fannie and Freddie were set up by the government, they are not owned or explicitly backed by the government. They are publicly traded companies owned by their shareholders.
However, Fannie and Freddie have become so big and important that everyone assumed that if they ran into trouble, the government would back them up. The housing bill signed by President Bush last week appears to do just that.
[3]: Stephenson, Neal. The Confusion. New York: Harper Collins, 2004. p. 128.
[4]: ibid. p. 484.
[5]: "Fed Selects Four Firms to Manage MBS Purchase Plan", by Craig Torres and Jody Shenn, Bloomberg, December 30, 2008.
The Federal Reserve chose BlackRock Inc., Goldman Sachs Asset Management, Pacific Investment Management Co. and Wellington Management Co. to manage a $500 billion purchase of mortgage-backed securities it plans to complete by June.
“They picked the crème de la creme of the money managers,” said Art Frank, head of mortgage-bond research at Deutsche Bank AG in New York. “By doing $500 billion by June, no question they’re doing their best to try to hold down mortgage rates.”
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Wow, much simpler than I imagined.
Thanks, John and Yo.
I’d become very concerned about this, two years ago.
I have some investments with Oppenheimer Funds, and a fair number of their ‘safe’ bond funds had LOADS of Agency debt.
This past week, it came out in the Oregonian newspaper that the ‘safe’ Oppenheimer/State of Oregon college fund is down almost 40 percent.
The reason of course, has to do with the fund’s reliance on Agency debt and MBS stuff. Big disaster, finger pointing.
Just glad I didn’t have THAT piece of the rock.
Thankyou John I look forward to the rest of your post on this. I know I can’t spot the difference.
Rich -
As it happens, neither can I
here’s further analysis from the folks who originally put up the 52-week chart:
“China has lost its appetite for risky assets”, by Brad Setser, Council on Foreign Relations, December 30, 2008.
The Fed giving money to banks to buy treasuries so the cash from treasury sales can be used to buy Agencies… A great way to print cash!
Want to know what happens to a short circuit? Things get very hot at first, then they either catch fire or blow up, or maybe both!
Wheee!