Treasury crash ...

Discussion in 'Economics' started by scriabinop23, Sep 7, 2008.

  1. Just wrote a new blog. No profit motives here. I just like analyzing and discussing this stuff. Please have a read and discuss.

    The paragraph that changed the world:

    <a href=" ">From Today's Fannie Mae & Freddie Mac press release today:

    <blockquote>Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. During this ongoing housing correction, the GSE portfolios have been constrained, both by their own capital situation and by regulatory efforts to address systemic risk. As the GSEs have grappled with their difficulties, we've seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers. While the GSEs are expected to moderately increase the size of their portfolios over the next 15 months through prudent mortgage purchases, complementary government efforts can aid mortgage affordability. Treasury will begin this new program later this month, investing in new GSE MBS. Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009. </blockquote>

    Nowhere do I see language specifying limits to MBS purchases. This sends a message with potentially scary results for anyone vulnerable to a high interest rate environment, since a large fraction of MBS agency exposure now becomes a potential liability to the US government. Considering $5 Trillion of mortgageback debt added to a $9 Trillion deficit (only $5 Trillion of that being due to parties other than the US government itself), this has an unavoidable potential to impact US debt credit quality, not to mention capital inflows towards dollar purchases.

    While the spread between agencies and treasuries will tighten, we may witness an environment where long dated debt of all types experiences skyrocketing yields, potentially undoing the benefit of this policy change.

    I can only imagine the Fed will counter this deflationary prospect with further supression of short term interest rates. At this rate, I could picture new mortgages being given with synthetically low rates created by some unnamed future program, not reflective of treasury yields or past agency spreads. This will incur further risk to government debt and call into moral question what level of involvement the government should have in the mortgage debt markets.

    On the bright side, a gigantic spread between fed funds (1% or under potentially) and 30 year debt (8%?) would result in an accelerated refunding of the banking system, that is unless the volumes of loans slowed enough to undo the net benefit of this spread. Or worst case: we could turn into a nation where all consumer and house loans were done on short term floating rates, since nothing on the long end would be affordable enough. This only opens the door for further nightmares when the government must eventually raise rates as the economy accelerates too quickly.

    The prolonged equity market reaction might not be as bullish as some of us hope either, since higher interest rates imply a higher demand for earnings yield, putting price support much lower. Furthermore, the effect of increased credit costs to companies does not need to be spelled out.

    The prospect of a Japan repeat for the U.S, with short term rates hugging 1% for a while, is a distinctly viable possibility. In summary, never before in my lifetime have I seen the credit quality of U.S. debt be possibly challenged. I would be surprised if the markets opened on Monday with complete denial of this prospect.

    For the sake of Pimco's Bill Gross, I hope he is short the spread between treasuries and agencies, because he may not get the pop he is desiring on agencies if he is long only.

    While it is obvious home prices need to come down closer to fundamental value in many areas, I hope all of this article is an incorrect postulation. The ramifications of this move could be disastrous and have depressive implications going forward. And since I am not exposed nor short to treasuries, I do not stand to benefit from this prognostication.
  2. cramer says big rally tomorrow. is he ever wrong?j/k
  3. I hope he is right so I can unload some SPY/QQQQ calls I had going into the weekend.
  4. pitz


    Sure, that 30 year debt would go from 5.5% to 8%, but it would also lose 30-40% of its value overnight, based on having a duration of ~15 years. Empirical duration on long-term MBS is expanding at a rapid pace right now because *nobody* is refinancing (because of no equity, and because of rising rates).

    How many years would it take for the banks to earn anything if that happened? A long, long time.. Lowering rates at this point would actually hurt the banks significantly. And since there's no refi's, nor purchases of new homes in the pipeline, there are virtually no customers for new debt.

    Either way, housing is trending towards zero, and the debt that funds housing eventually will trend towards zero. Like the tech sector 8 years ago, the financial sector will be decapitalized for years to come.

    That's how its done in most places outside the US. People don't leverage themselves to the hilt as a result, as they have to maintain some cushion just in case rates change. Its not the end of the world to not have 30-year loans.

    Canada, for instance, >90% of fixed house loans are done for 5 years. People still own houses there, they don't live in igloos or mud huts..

    No, it merely means that people live within their means. Seriously, taking 30 years to pay off a house is ridiculous.

    But indebted firms will be able to report gains because of a deterioration in the fair value of their debt obligations.
  5. None of this is bullish. We may have the two day jam job, but thats it.

    this whole system is failing
  6. This is never ending now as banks holding FRE and FNM stock have to be bailed out as well.

    Regulators to Help Banks With Fannie, Freddie Shares (Update2)

    By Alison Vekshin and Linda Shen

    Sept. 7 (Bloomberg) -- U.S. regulators said they will help develop plans to restore capital at banks with ``significant'' holdings in Fannie Mae and Freddie Mac after the government seized control of the two mortgage-finance companies.

    The Federal Reserve and three other banking agencies ``are prepared to work'' with smaller banks whose stakes in Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac represent a large share of their capital, the regulators said today in a joint news release.

    The Treasury Department and the Federal Housing Finance Agency today placed the companies under a so-called conservatorship, replacing their chief executives and eliminating dividends. Common stockholders of the government- sponsored enterprises, weakened by a surge in mortgage defaults, will be last in line for any claims, Treasury Secretary Henry Paulson said at a Washington news conference. Preferred shareholders will be second in absorbing losses, he said.

    The takeover is ``unambiguously bad'' for preferred shareholders who, along with holders of common stock, ``will in all likelihood be wiped out,'' Gimme Credit LLC analyst Kathleen Shanley said today in a statement. ``The government opted not to sweeten the pill for bank holders of preferred stock,'' in a move ``likely to set a precedent for any future rescue transactions,'' Shanley said.

    `Outsized' Stakes

    Regulators may be concerned the market will think smaller banks' capital will be completely depleted, said Ira Jersey, a Credit Suisse Holdings USA Inc. interest-rate strategist. He said his said research showed only ``five or six banks'' may have ``outsized'' stakes in the Fannie Mae and Freddie Mac compared with their capital.

    Small lenders have been the hardest hit as banks are being closed by federal regulators at the fastest pace in 14 years amid the worst housing slump since the Great Depression. This year's total reached 11 on Sept. 5 when Silver State Bank of Henderson, Nevada, was shuttered.

    ``Across the industry, banks do not have significant exposure to GSE equity securities,'' Federal Deposit Insurance Corp. Chairman Sheila Bair said today in a statement. ``Any negative impact will be narrowly focused only on a few smaller institutions.''

    Paulson urged banks to contact their primary federal regulator if they believe losses on holdings of common or preferred shares in Fannie Mae or Freddie Mac will cause them to fall below the government's benchmark for ``well-capitalized'' institutions.

    Besides the Fed and FDIC, the Office of the Comptroller of the Currency and the Office of Thrift Supervision also signed onto today's release.

    The OTS, which regulates savings and loans, expects the seizure of Fannie and Freddie to have ``a negligible impact'' since less than 1 percent of the institutions it oversees have significant concentrations of GSE stock, OTS spokesman Bill Ruberry said in an e-mail statement.
  7. pitz


    I wouldn't say 'failing'. "Reverting to fair value" would be a better way of putting it...

    Its truly amazing that any entity, domestic or foreign, would lend money to anyone in the United States, a place where inflation is running > 5%, for less than inflation.

    Its truly amazing that anyone would lend money against housing, a fundamentally depreciating asset, at miniscule spreads against treasuries.

    Its truly amazing that oil and mineral firms that produce real value and real wealth can trade at 4-5X earnings, while some condo in Orange County trades at 50-80X earnings...
  8. Exactly.
  9. Too true! If wasn't for the name USA printed on the debt we would only be lent debt at double digit rates if at all.
    #10     Sep 7, 2008