Wednesday, September 10, 2008

The F&F mess...


Bailout shows waning of U.S. financial power: James Saft
Wed Sep 10, 2008 7:23am EDT
-- James Saft is a Reuters columnist. The opinions expressed are his own --
By James Saft

LONDON (Reuters) - American financial hegemony -- the United States' ability to borrow at attractive rates despite its spiraling debts -- ain't what it used to be.

When he introduced the first bailout of Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) back in July Hank Paulson thought his pledge of government support, if needed, would be enough to ease investor pressure on the now-nationalized lenders.

"If you have a bazooka in your pocket and people know it, you probably won't have to use it," the U.S. Treasury Secretary told a Senate Banking Committee hearing on July 15.

Time was, that would be enough for America's global creditors.

But Paulson's pledge turned out to have more in common with Chekhov's gun, which the writer said once introduced into a story must inevitably be fired.

Despite the extraordinary reassurances, foreign investors in Fannie Mae and Freddie Mac debt staged an effective buyers' strike, forcing the mortgage giants to pay a crippling premium of around one percentage point over Treasuries to borrow.

With money that expensive the two lenders, or at least one of them, would have grave trouble earning enough money to dig themselves out of their hole and make good their guarantees on trillions of dollars worth of mortgages, many of which are now likely to default.

Think about it: the U.S. Secretary of the Treasury effectively said he'd sort it out if it went bad and the world said that wasn't good enough. The move to take the two into conservatorship is really an earth shaking event.

"I suspect this is the first case where foreign central banks exercised their leverage as creditors to push the U.S. government to make a policy decision that protected their interests," economist Brad Setser, who follows central banks at the Council on Foreign Relations, wrote in his blog.

The plan could at a stroke unblock some of the clogged arteries of finance, allowing homeowners to borrow more cheaply and taking away at least one of the forces driving house prices downward. It also throws up huge questions about how the United States will finance its housing after the current cooling down period ends, which may, by the way, be sooner than many would like.

But the bailout may yet acquire even greater significance by marking a turning point in the nation's relationship with its creditors.

America is a debtor nation, with a huge current account deficit and insufficient savings.
The dollar actually rallied on the news, an extremely encouraging sign, but it has to be noted that at the time of writing 10-year treasury yields were about 25 basis points higher than they were before news of the conservatorship emerged on Friday. That is likely to be partly position covering by investors who were long Treasuries and short Fannie and Freddie debt, but it also must reflect in part concern over the ultimate cost of the bailout and the inflationary impact of potentially issuing huge amounts of debt to fund it.

One argument advanced for why the government decided to step in now was that a recent review of Fannie's and Freddie's books had revealed capital issues.

While I have great respect for the ability of Morgan Stanley bankers, who combed through the mortgage lenders' entrails, I doubt that they've found much that was not known before by regulator James Lockhart and his team.

The two big changes that have happened since July are the continued negative news on housing, with something like 9 percent of American mortgages now in arrears or in foreclosure, and the simple unwillingness of investors to extend Fannie and Freddie cheap credit.

That should get better now, especially given government plans to buy mortgage securities directly, and mortgage rates will be headed lower for those able to get one. Freddie Mac sold three-month bills on Monday at a yield 46 basis points lower than a sale six days before and Fannie and Freddie debt risk premiums fell across the board.

But note that mortgage securities issued by Ginnie Mae, which have an explicit government guarantee, were before the news trading only about 25 basis points lower than Fannie and Freddie mortgage-backed securities. That may imply limited appetite for U.S. mortgage paper under any circumstances.

The big question, the solution of which will be politically determined, is what form Fannie and Freddie take in the future and what arises to replace part or all of them.

Under the terms of the plan, the two will expand their purchases of mortgages through the end of next year, but then begin scaling back. Paulson left open the possibility that the government guarantee is removed.

I cannot see that happening. Home prices will still fall from here and at the point at which the next President and Congress are deciding whether or not to de-nationalize the mortgage market, housing and the economy will still be in the dumps.

The United States is likely to have a government-guaranteed mortgage market for a very long time, but I question how long the rest of the world will be willing to play along.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund --
(Editing by Ruth Pitchford)
© Thomson Reuters 2008. All rights reserved. Users may download and print extracts of content from this website for their own personal and non-commercial use only. Republication or redistribution of Thomson Reuters content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters. Thomson Reuters and its logo are registered trademarks or trademarks of the Thomson Reuters group of companies around the world.
Thomson Reuters journalists are subject to an Editorial Handbook which requires fair presentation and disclosure of relevant interests.

I posted previously stating that the CBO estimate bailout cost to the taxpayer of 25Billion was too low and 250 Billion was more likely the right number.... Well here we are. My only hope is that 250 is upper bound not the lower...