Back in late July when "The Housing and Economic Recovery Act of 2008" was signed into law, giving the U.S. Treasury permission to purchase unlimited stakes in Freddie Mac and Fannie Mae, Treasury Secretary Henry Paulson said the following, "If people know you have a bazooka, they won't make you use it." What he meant was, now that the world knew he had the power to effectively make the U.S. Government guarantee of Freddie and Fannie EXPLICIT, it would be enough to restore confidence amongst senior debt holders and holders of the mortgage backed securities guaranteed by the GSEs. It hasn't.
On Monday, Freddie Mac sold $3 billion of five-year senior debt at a spread of 1.13% over the risk-free five-year Treasury note. Asian institutional participation was only 30%, down from 41% in the May five-year auction. The spread in the May auction was .69%. The debt investors aren't stupid. I'm sure they fully believe that Freddie and Fannie debt is now fully guaranteed by Treasury. However, until that guarantee truly becomes explicit with a injection of capital from Treasury, they hold all the cards. They can pretend that they are worried and back bid all they want. I could just imagine what was going on over last weekend as Freddie and the Wall Street syndicate managers fretted and prayed that the auction would go off "smoothly". The debt investors, especially the Asian ones, know they are the hottest girl at the dance. The can play coy and act like they might just sit this dance out. And look what happened, they just bought U.S. Government guaranteed debt 1.13% over similar Treasury debt. Bully for them and woe is to us. That costs Freddie (soon to be "us") about $190 million.
Freddie and Fannie have $223 billion more debt rolling between now and the end of September. It's time for Hank to take out the bazooka and put this issue to bed before we end up paying $ billions more in interest payments. If you were the debt buyers, wouldn't you gleefully keep playing this little game until you couldn't anymore? I know I would. Hank Paulson has to do one of two things. Either step up and twist the GSEs arms behind their back and make them "invite" Treasury to invest, or show the exhaustive analysis that Treasury must have done to show Paulson that both GSEs were solvent and viable, therefore, not needing government capital. Do you think that analysis exists? Somehow, I doubt it. If something like that, something that wouldn't make the most cynical accountant laugh his ass off existed, we would have seen it so many times that we would be sick of it. It's time to end the charade.
Meanwhile, we have mortgage rates going higher and higher because Freddie and Fannie mortgage backed securities ("MBS") are experiencing the same difficulties, plus another big one. If Freddie and Fannie get taken over, what will the future of the secondary mortgage market be?
- Are they still going to make Freddie and Fannie MBS?
- Are they going to merge the two GSE and just make Fannies (this will have lots of profit and loss implications for holders of Freddie MBS)?
- If they decide to stop making Freddie and Fannie MBS, what's the alternative?
All these questions need to be answered, and issued in a clear, rational, unified and confident voice. Until then we have, "Who knows?". I can assure you one thing, "Who knows?" is not good "technical" for any market. Unfortunately, this market is the one that essentially sets our mortgage rates and its going in the wrong direction.
One last thing before I exhort Hank to show his bazooka (heh-heh...heh-heh), according the the Housing Rescue legislation, Freddie and Fannie have to ASK Treasury to come in. That's a good one! It essentially means that Dick Syron and Dan Mudd have to call over to Treasury and ask to be fired! You think they are going to do that on their own? For two guys who had the gall to take down $30 million last year, when they knew that the future wasn't going to be "stellar", you think they'll do the right thing? I doubt it. They are like a ball-player with a "no-trade clause" who is killing the team with his play and his fat guaranteed contract. I suggest Hank Paulson call a smart sports general manager like the Red Sox's Theo Epstein and ask how he got rid of Manny Ramirez!
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