I have to hand it to Asia, they are playing this one beautifully. Story in Bloomberg today, "Fannie Mae Rescue Hindered as Asians Seek Guarantee."
Feb. 20 (Bloomberg) -- Asian investors won’t buy debt and mortgage-backed securities from Fannie Mae and Freddie Mac until they carry explicit U.S. guarantees, similar to those given on bonds issued by Bank of America Corp. or Citigroup Inc. The risks are too great without a pledge that the U.S. will repay the debt no matter what, according to Hideo Shimomura, chief fund investor in Tokyo for Mitsubishi UFJ Asset Management Co., and other bondholders and analysts in Japan, China and South Korea interviewed by Bloomberg. Overseas resistance may hamper U.S. efforts to hold down home-loan rates and rebuild the nation’s largest mortgage-finance companies.
Even after President Barack Obamavowed on Feb. 18 to sink as much as $400 billion of capital into Fannie Mae and Freddie Mac, double the original commitment, “there is still a concern that there is no guarantee” from the government, said Shimomura, who oversees $4 billion in non-yen bonds for the arm of Japan’s largest bank.
“Looking at the risk, they’re not so attractive,” he said. “We need a guarantee before we’ll buy.”
The government has been trying like the dickens to avoid having to put the explicit full faith and credit guarantee behind Freddie and Fannie and now the jig is up. The reason Treasury has been doing, as Gregory Hines would have called it, "The Ethiopian Shim-Sham" is because if the U.S. Government has to explicitly back $1.7 trillion of GSE debt (we haven't even talked about the FHLBs yet) as well as $3.7 trillion of mortgage backed securities we will more than double Treasury's current debt. Now that Treasury and the Fed, using Freddie and Fannie, are looking to launch the mother of all refinancing waves, Asia is essentially saying, "We'll take the $billions that come to us at par when these securities prepay and put some to work in the markets Treasury or FDIC has extended the full faith and credit of Uncle Sam to, and the rest of the dollars....we'll cross that bridge when we get there."
Asia saying they are not going to play ball with regard to financing Freddie and Fannie, which they are going to need as they grow their retained portfolios, or by buying new, shiny Fannie and Freddie 4% MBS, means President Obama's big housing program has a big problem. Asia declaring a buyers strike on new MBS purchases, just as we ready to make a few hundred billion new ones (talking gross supply here, net will be smaller because many "new" securities will be the result of refinance driven prepayments of older MBS) is going to put TREMENDOUS pressure on the MBS market and, all else equal, push mortgage rates in the wrong direction.....UP. What that means is THE BUYER of all these new MBS will be the Federal Reserve and Treasury. To drive mortgage rates lower they will have to buy at increasingly tighter and tighter levels. That will end up in a situation technical that fixed income specialists call F.U.B.A.R. The government will own at least $750 billion of these new MBS right around a price of 100-00. History has shown us that just when the last forced purchase takes place, interest rates like the ten-year Treasury will go from 2.85% to 5.00%, moving the dollar price of those MBS to a price less than 80-00! A twenty percent loss on $750 billion is a cool $150 billion. Hi-ya!
I'd expect Treasury to extend the full faith and credit to GSE debt and MBS by early next week.