FT.com has reported that the Bank of China has sharply reduced its Fannie/Freddie securities holdings but sharply increased its holdings of US Treasuries. Is this a sign of things to come? Do they know something we don’t?
This is exactly the reason the Treasury should not give an open-ended, retroactive and explicit guaranty of the trillions in mortgage guarantees made on some of the worst loans to ever come out of the USA. While retroactively protecting a group by backing the debt, you throw those who own US Treasuries under the bus. That would be a real blow to investors and a much broader base of investors at that. I spoke in detail about this earlier this week in my piece ‘Fannie/Freddie – Who Gets Thrown Under the Bus?’
Remember, Fannie and Freddie have near $700 billion in subprime and Alt-A combined. Much of their Prime paper is many grades lower than originally rated due to their deeply flawed automated underwriting systems, DU and LP, during the bubble years, and now crashing house values. Much of the mortgage backed debt is owned by foreign Governments, banks, mutual funds, pension funds and rich investors such as Bill Gross and his clients. These investors knew full well this paper was not backed by the Government, but chose to invest anyway for yield over US Treasuries. They were taking a risk and were rewarded for years with higher yield.
If a retroactive, explicit and open-ended guaranty is given on debt that has never been guaranteed in the past, just as defaults and foreclosures are surging among all paper grades and with house prices continuing to crash, it could be disastrous for US Treasuries. We don’t know for sure the future default rate on loans the GSE’s made, but rest assured it will be much higher than everyone thinks. Without the guarantee, the trillions in mortgage backed debt may lose some value, but the damage is not as great as with Treasuries. The loss is manageable if “isolated” to the past GSE paper.
Bill Ackman actually spoke about a great plan to solve this problem and adequately back investors, which is important, and needless to say most important to the investors. Below are the links.
Threats are flying already. But what does “compensated adequately” mean? Perhaps ownership in the new Fannie/Freddie if indeed their GSE holdings lose value. This would pay big over the next 10-20 years but likely would involve a loss in value immediately. And, they are not considering what would happen to US Treasury values if Fannie/Freddie debt is becomes open-ended, retroactive and explicit guarantee.
“A failure of US mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system”, Yu Yongding, a former adviser to China’s central bank, says.
“If the US government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to Bloomberg. “If it is not the end of the world, it is the end of the current international financial system.”
There should no problem with explicitly guaranteeing loans going forward after the firms are nationalized. As a matter of fact, the GSE’s are now making some of the best loans ever. With an explicit guarantee going forward, tighter lending guidelines and higher mortgage rates and spreads over Treasuries, investors should have no problem buying up the issues. They would be in such hot demand that it could conceivably make actual mortgage rates cheaper on the front end than they are today.
Without an explicit, retroactive and open-ended bailout that saddles the US tax payer with TRILLIONS in liability, people are worried that these players, especially foreigners, will quit buying Treasuries. Well, that’s the risk you take. But at this point in time that is just speculation.
As clearly reported in FT.com, many of these investors have already significantly lightened their Agency exposure. Strangely enough, even more so around the time the news began to break that the GSE’s were in trouble and there were questions surrounds their ‘implicit guaranty’. -Best, Mr Mortgage
Bank of China flees Fannie-Freddie
By Saskia Scholtes in New York and James Politi in,Washington. Published: August 29 2008 03:00 | Last updated: August 29 2008 03:00
Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June.
The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.
Foreign investors have been a mainstay of the market for such debt, but uncertainty over the mortgage financiers’ capital positions and the timing and structure of a potential government rescue has made some investors reassess their exposures. Asian investors in particular have become net sellers of agency debt, said analysts.
Federal Reserve custody data shows that for the year to July, foreign official and private investors bought an average of $20bn of agency debt a month, including debt issued by other government agencies such as Ginnie Mae and the Federal Home Loan Banks. Purchases of US Treasuries averaged $9.25bn.
From July 16 to August 20, foreign investors sold $14.7bn of agency debt, trimming their overall holdings to $972bn. They purchased $71.1bn of Treasuries in the same period. (STORY CONTINUED THROUGH LINK AT TOP OF STORY)
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