Wednesday, September 10, 2008

What's The Next Financial Shoe To Drop?

So Freddie and Fannie Are "Safe" - But What's Next?
In case you didn't hear, the government finally jumped into the mortgage business over the weekend when the politicians officially nationalized Fannie and Freddie. Without an official guarantee from Washington, the odds of a full-scale mortgage-backed crash was imminent. So you could argue Paulson's pre-emptive strike on Sunday was successful. Spreads, or the difference between risk-free Treasury bonds and mortgage-backed debt, remained elevated all year until this past Monday. That rate was 2.74% last Friday or 6.40% - the highest spread versus T-bonds since the credit crisis began. Meanwhile, the 30-year fixed rate mortgage plunged from over 6.40% on Friday to 6.04% on Monday. In other words, the bailout alleviated credit stress on that segment of the mortgage market. That's the good news.The bad news is that "jumbo" mortgage rates, or mortgages considered too large to be purchased by Fannie and Freddie climbed to 7.35% from 7.14%. How the jumbo market will react going forward is anyone's guess. But the primary concern for the market is that lending giants Fannie and Freddie remain solvent and recapitalized by the federal government. Paulson, a former Goldman Sachs chief, is no stranger to structuring deals. In some ways, the United States and its foreign creditors are lucky because anyone else holding this position would have no idea how to put together such a complex rescue package. Here's the plan: The Treasury will recapitalize the government-sponsored enterprises (GSEs) by gradually buying preferred stock. Of course, stock holders will get the short end of that stick. Fannie and Freddie shares collapsed about 85% on Monday. I've already purchased intermediate and short-term Fannie and Freddie debt. Spreads should continue to narrow over the next several weeks as investors return to this market. These bonds, along with high quality corporate bonds are among the best values today in fixed-income markets. In stark contrast, treasury bonds offer you poor values adjusted for inflation. They're also overbought.Taxpayers, naturally, will fund this enormous bailout. The Savings & Loans crisis in the late 1980s cost taxpayers about US$300 billion adjusted for inflation since 1989. This bailout should easily match those figures. It might ultimately be twice that amount if housing values don't stop falling soon.Bear Stearns, Fannie and Freddie. Who's next?

1 comment:

Anonymous said...

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