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That raises the question of whether at some point the administration might abandon the remaining ambiguity about their status and declare that it stands full-square behind [Fannie Mae's and Freddie Mac's] debts. [1]
What we are seeing now is a huge dilemma for Treasury. As soon as they say that the government guarantee on GSE Agency Debt, the senior bonds issued by enterprises like already semi-nationalized Freddie Mac and Fannie Mae, is "explicit" then the White House Office of Management and Budget (OMB) will have to acknowledge the US National Debt is about twice as big [2] as the present official figure. Read the story the above quote came from [1] closely and you will note a sort of mathematical limit — spokespeople are approaching the precipice arbitrarily closely, but never actually cross.
Pressure on Agency Debt is steadily building. Al Yoon is reporting both that conforming mortgages at the heart of the GSEs’ book of business are facing the threat of ratings downgrades [3] and that the GSEs may have to buy even dodgier legacy paper from private sector mortgage originators [4] so that Obama’s housing bailout can work. That bailout not only doubled Treasury’s direct support of Fannie & Freddie to $400 billion, but as Doom noted Wednesday it was reported [5] that "the plan extended the government’s line of credit with the GSE’s and enabled Treasury to take an equity stake in the firms." All this comfort may not be enough, however. There are increasing signs [6] that the foreign buyers of agencies are demanding that the government guarantee on these bonds be made explicit.
Agency Debt really started teetering on the brink of becoming a sovereign obligation of the United States on October 23, 2008 when then (and presently serving) FHFA Director and Bush protege Jim Lockhart testified to Congress that in the wake of their being seized into FHFA conservatorship Fannie & Freddie enjoyed an explicit government guarantee on their senior debt. In the frantic and confused retreat from that statement the formerly "implicit" guaranty on agencies was rebranded as "effective," and it has remained the unofficial policy of the government, extending to the new administration, that the guarantee will become "more and more effective" to appease investors’ fears, but will never again threaten to tip over into "explicit."
That has the effect of drawing a bright line firmly under treasuries. Agencies remain definitively junior to America’s real sovereign obligations, so in the unlikely event that Uncle Sam is forced by circumstances to administer a haircut on government supported paper, imposing a loss on Agency Debt holders would not (quite) imply breaking faith. In the past I’ve termed this remote possibility Sovereign Default Lite. But on the other hand as the effective guarantee approaches explicit as a limit, there is the risk it may someday accidentally stray into explicitness. The mind boggles imagining how the models at Moody’s, S&P and Fitch could be tweaked to preserve America’s AAA debt rating if the amount of that debt were to suddenly double.
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Notes and References
[1]: "Grip tightened on Fannie and Freddie", by Krishna Guha and Saskia Scholtes, Financial Times, February 20, 2009.
[2]: "Fannie, Freddie and the Ballooning U.S. Balance Sheet", by Tom Lindmark, Seeking Alpha, February 21, 2009.
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Now you can see the extent of the problem. An explicit guarantee is going to bring the two on balance sheet, which would more or less double the reported debt of the country. That may only be a recognition of reality, but it does have consequences. …
[3]: "Mortgage "AAA" bond downgrades could double – Citi", by Al Yoon, Reuters, February 20, 2009.
[4]: "US mortgage plan hikes bond investor risk – Amherst", by Al Yoon, February 20, 2009.
[5]: "Treasury Boosts Funds For Fannie,Freddie To $200 Billion Each", by Maya Jackson Randall and Jeff Bater, February 18, 2009.
[6]: "Asian Investors Hold Out for Explicit Guarantee on GSEs", by Paul Jackson, Housing Wire, February 20, 2009.
Are we talking about the same rating agencies that rate CDOs here? They’ll say AAA no matter what, period, and models be damned.
And it seems unlikely that this will be put on the books anyway – the government has little incentive to act honestly here. I doubt foreign central banks are going to start screaming about it knowing that they should’ve seen it all along, and telling the American people we’ve suddenly doubled the size of the national debt to pay other people’s mortgage obligations is certainly not something that will sit well, at least with half of the population.
Then again, the other half may well support this if for some reason it becomes necessary, and you only need 51% (if that), right? They’ve already spent a trillion this week and are proposing to bump it by another 300 billion next week, what’s another few trillion. It’s all just paper, right? If you have no savings, and the government is going to meet all your needs for medical care and everything else, why do you care about currency devaluation? No one will think about the longer term effects, because most politicians will be out of office by the time those things come to pass, and the majority of voters are not, sadly, voting for preserving the dollar or the American dream or anything else for the future, they’re voting based on the handout they can get right now. I want Obama to pay for my $800k home and retirement! So it goes with the buy now pay later generation.
Jim,
You are so right. This selfish thinking from the government officials/ceo’s and the majority of the United States citizens has caused this whole mess. Whats worse is that this thinking is still quite prevalent and will not stop until everything totally collapses, which is probably not far off.
Igor is right again when he says “gloomy”
John–
I hadn’t realized that by keeping a little wiggle room in their guarantee, the government was keeping the Fannie/Freddie debt off balance sheet. With Pres. Obama’s rhetoric about reducing the federal debt two-thirds by 2013, I suspect that the pressure will be on to keep the guarantee fuzzy. However, the administration will have no choice but to fold as foreign investors apply pressure on the treasury to step up and give the explicit guarantee, or they will take their money and go home
Were they talking about reducing the federal debt by 2/3? I thought it was just slowing down the rate of deficit spending (and even that seemed pretty unlikely in real life…).
Isn’t it funny that cuts in government spending are always years away (and taken credit for before they ever happen, so that people can forget and the media can decline to mention it when they don’t happen at all) while the need to spend is always right now…
Mr. Twist -
What do you make of this? Ambrose manages to discuss East Asia’s concerns on treasuries and Hillary’s soothe-fest without dealing with agencies at all.
“Hillary Clinton pleads with China to buy US Treasuries as Japan looks on”, Ambrose Evans-Pritchard, Telegraph, February 22, 2009.
John–
Clearly, the Obama admin. has gotten the word to Hillary to play nice with the Chinese. I’m sure the Obamaites are very concerned that if the Chinese find some other place to put their $40 billion monthly account surpluses, we might not be able to fund all of our bail-out plans. Ambrose does talk about the possibility of a back-door default by the US through inflation (which kills the value of bonds), and I’m sure that foreign purchasers of both treasuries and agency debt will keep an eye our our inflation numbers going forward.