Subscribe to this blog's feedThe markets reckon there's a 75% chance he'll keep his word on the GSEs, Brad DeLong calculates. Given yesterday's Freddie Mac bond issue, priced at 113bp over Treasuries...
It is hard to see a bankruptcy of Freddie Mac costing its bondholders more than 1/5 of their capital. That means that risk-neutral investors would have to rate the odds of a Freddie Mac bankruptcy over the next five years at 1/4 or they would be willing to hold five-year Freddie Mac debt at a higher price than they are.
Quite a premium - even though, as Felix Salmon points out, "Paulson has made it crystal clear that he stands behind that debt."
His take on it:
So let's say that a large number of historical buyers of GSE debt (like, say, the Chinese government) decided that if they wanted to take US government risk, they'd much rather just buy US government debt, rather than relying on not-entirely-explicit pronouncements from the Treasury secretary. Right now, there's not a huge amount of liquidity in global debt markets, and the absence of those buyers can drive rates up quite a lot. It might look irrational -- it might be irrational -- but it's not hard to see how a company in trouble will have difficulty raising billions of dollars these days, no matter how much government support it has.
Barry Ritholz outlines the GSEs' fatal arrogance:
it was a mad grab for growth that sent Fannie into the arms of the most risky mortgages.
Fannie was supposed to be buying mortgages and then securitizing them itself. Instead, Fannie Mae thought itself a large hedge fund, and was investing in RMBS and derivatives packaged by others. According to regulatory data, as far back as 2002, Fannie Mae had invested in "tens of billions of dollars of such securities."
And Yves Smith goes through estimates of how much the GSEs need to raise, and agrees that "GSE paper's rates ALWAYS presupposed a Federal guarantee. Those tight spreads made no sense based on their stand-alone financials. Now that guarantee is being tested, and the government has blinked. Any wonder the market is spooked?"
