Economic and market consequences of FNM/FRE bailout

C

Cutten

I think it's pretty much a given that the US govt will bail out these two institutions. If they bail out Bear Stearns, they can hardly let the country's 2 quasi-governmental mortgage underwriters go bust.

The total assets of the two companies amounts to about $5 trillion, if the figures are to be believed. So if the US govt bails them out, that is potentially $5 trillion on the national debt - at least in a strict accounting sense. That amounts to over 1/3 of US GDP, and would take the already skyrocketing US debt up to pretty much 100% of GDP. Bear in mind that when Bush took office the debt to GDP ratio was in the 30s. Now people assume most of this will not have to be written off, but we don't really know that. With a bad enough real estate slump, you could easily see hundreds of billions of even 1 trillion+ of losses to the government.

This could have pretty severe consequences for the US Treasury market and the dollar. Rating agencies may well downgrade the sovereign debt, like they did with Japan a few years back during its slump. This could easily trigger mass selling by other countries' central banks, foreign pension funds and investors, as well as domestic US institutions. Since the US current account deficit is so large, this would pretty much screw the dollar. It is not beyond the realm of possibilities to see the 30 year bond going to say 8-10% yield and the dollar falling 20-30% in this scenario.

It's not something I would put as certain or even probably, but it is an outlier scenario worth considering. If it starts to look like it's happening, then Euro and Yen calls, and T-bond and T-note puts would like very attractive. Another play is to go long some foreign government debt and short the US 10 or 30 year. I think UK gilts are a good candidate for this trade, as the Uk economy looks in dire shape for the next 12-18 months or so, yet they yield more than Bunds. With this long gilt short T-note spread, you are mostly hedged against global yield curve shifts, earn a small carry, and effectively have a free put on a US debt downgrade and/or dollar panic.

Any other suggestions for potentially playing this?
 
Long 2-year Treasuries and short 10 year notes or 30 year bonds.

The long-dated paper will get hit much harder than the 2 year notes

Quote from Cutten:

I think it's pretty much a given that the US govt will bail out these two institutions. If they bail out Bear Stearns, they can hardly let the country's 2 quasi-governmental mortgage underwriters go bust.

The total assets of the two companies amounts to about $5 trillion, if the figures are to be believed. So if the US govt bails them out, that is potentially $5 trillion on the national debt - at least in a strict accounting sense. That amounts to over 1/3 of US GDP, and would take the already skyrocketing US debt up to pretty much 100% of GDP. Bear in mind that when Bush took office the debt to GDP ratio was in the 30s. Now people assume most of this will not have to be written off, but we don't really know that. With a bad enough real estate slump, you could easily see hundreds of billions of even 1 trillion+ of losses to the government.

This could have pretty severe consequences for the US Treasury market and the dollar. Rating agencies may well downgrade the sovereign debt, like they did with Japan a few years back during its slump. This could easily trigger mass selling by other countries' central banks, foreign pension funds and investors, as well as domestic US institutions. Since the US current account deficit is so large, this would pretty much screw the dollar. It is not beyond the realm of possibilities to see the 30 year bond going to say 8-10% yield and the dollar falling 20-30% in this scenario.

It's not something I would put as certain or even probably, but it is an outlier scenario worth considering. If it starts to look like it's happening, then Euro and Yen calls, and T-bond and T-note puts would like very attractive. Another play is to go long some foreign government debt and short the US 10 or 30 year. I think UK gilts are a good candidate for this trade, as the Uk economy looks in dire shape for the next 12-18 months or so, yet they yield more than Bunds. With this long gilt short T-note spread, you are mostly hedged against global yield curve shifts, earn a small carry, and effectively have a free put on a US debt downgrade and/or dollar panic.

Any other suggestions for potentially playing this?
More...
 
Quote from Cutten:

I think it's pretty much a given that the US govt will bail out these two institutions. If they bail out Bear Stearns, they can hardly let the country's 2 quasi-governmental mortgage underwriters go bust.

The total assets of the two companies amounts to about $5 trillion, if the figures are to be believed. So if the US govt bails them out, that is potentially $5 trillion on the national debt - at least in a strict accounting sense. That amounts to over 1/3 of US GDP, and would take the already skyrocketing US debt up to pretty much 100% of GDP. Bear in mind that when Bush took office the debt to GDP ratio was in the 30s. Now people assume most of this will not have to be written off, but we don't really know that. With a bad enough real estate slump, you could easily see hundreds of billions of even 1 trillion+ of losses to the government.

This could have pretty severe consequences for the US Treasury market and the dollar. Rating agencies may well downgrade the sovereign debt, like they did with Japan a few years back during its slump. This could easily trigger mass selling by other countries' central banks, foreign pension funds and investors, as well as domestic US institutions. Since the US current account deficit is so large, this would pretty much screw the dollar. It is not beyond the realm of possibilities to see the 30 year bond going to say 8-10% yield and the dollar falling 20-30% in this scenario.

It's not something I would put as certain or even probably, but it is an outlier scenario worth considering. If it starts to look like it's happening, then Euro and Yen calls, and T-bond and T-note puts would like very attractive. Another play is to go long some foreign government debt and short the US 10 or 30 year. I think UK gilts are a good candidate for this trade, as the Uk economy looks in dire shape for the next 12-18 months or so, yet they yield more than Bunds. With this long gilt short T-note spread, you are mostly hedged against global yield curve shifts, earn a small carry, and effectively have a free put on a US debt downgrade and/or dollar panic.

Any other suggestions for potentially playing this?
More...

they have 5 trillion of debt. but at the highest estimates the delinquincy rate is only 1%, so that would be 500 billion dollars of possible debt. or about 3x the stimilus package we just had. 5 trillion number is silly. i don't think 100% of all houses will defalt on there house.

usa debt is about 9.5 trillion $$. but our economy gdp is 14 trillion, and growing faster then our debt. most nations have a higher debt/gdp ratio then us. japan is 194%. the uk, France Germany and Canda all have a higher debt ratio then us.

SO it would not be a big deal
 
Quote from Cutten:

I think it's pretty much a given that the US govt will bail out these two institutions. If they bail out Bear Stearns, they can hardly let the country's 2 quasi-governmental mortgage underwriters go bust.
More...


The government didnt bail out Bear Stearns. They got some help from the FED and then JPmorgan bought it (again facilitated by the FED). But the government had absolutely nothing to do with it. So realise that this is a completely different situation.

FRE & FNM are not shareholders in the FED (at least, AFAIK) and that's why Poole says that the government (the tax payers) should bail them out instead of the FED (well, also since those companies were created by congress in the first place). The FED is only going to bailout their own shareholders.
 
Quote from luckybastard:

The government didnt bail out Bear Stearns. They got some help from the FED and then JPmorgan bought it (again facilitated by the FED). But the government had absolutely nothing to do with it. So realise that this is a completely different situation.

FRE & FNM are not shareholders in the FED (at least, AFAIK) and that's why Poole says that the government (the tax payers) should bail them out instead of the FED (well, also since those companies were created by congress in the first place). The FED is only going to bailout their own shareholders.
More...











Here is the play by play commentary regarding the collapse of Bear Stearns for anyone that is interested.

Great article...
http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808
 
the bail out could be much higher than the normal default rates depending on how much sub:alt-a crap the Fed dumped on the agencies..

and since the accounting was dodgy before all of this no telling what will happen.

I've read where some tranches are in default by 20%+
 
Just like Bear Stearns, FRE and FNM are "well capitalised"

STATEMENT OF OFHEO DIRECTOR LOCKHART ON FANNIE MAE, FREDDIE MAC

(The following is a reformatted version of a press release issued by OFHEO and received via electronic mail. The release was confirmed by the sender.)

July 10, 2008

STATEMENT OF OFHEO DIRECTOR JAMES B. LOCKHART

"OFHEO has been monitoring and continues to monitor closely Fannie Mae, Freddie Mac and the mortgage and financial markets. As one would expect, we are carefully watching the Enterprises' credit and capital positions.

As I have said before, they are adequately capitalized, holding capital well in excess of the OFHEO-directed requirement, which exceeds the statutory minimums. They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets.

At the time of our March 2008 capital agreement with the Enterprises I said: `OFHEO will remain vigilant in supervising the safe and sound operations of these companies, and will act quickly to address any deficiencies that may arise. Furthermore, we recognize the need to ensure that their capital levels are strong, protecting them from unforeseen risks as the market recovers.'

Including the $7.4 billion Fannie Mae raised in May in accordance with our March agreement, the Enterprises have raised over $20 billion in capital. They are using it to continue to grow and to play a critical role in the mortgage markets, which we expect them to continue to do. To support their mission, Freddie Mac is committed to raising an additional $5.5 billion, which they will do given appropriate market conditions.

At a very difficult time in the market, the Enterprises have the flexibility and sound operations needed to support their mission."

OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.

Contact Corinne Russell (202) 414-6921

Stefanie Mullin (202) 414-6376
 
Quote from luckybastard:

The government didnt bail out Bear Stearns. They got some help from the FED and then JPmorgan bought it (again facilitated by the FED). But the government had absolutely nothing to do with it. So realise that this is a completely different situation.

FRE & FNM are not shareholders in the FED (at least, AFAIK) and that's why Poole says that the government (the tax payers) should bail them out instead of the FED (well, also since those companies were created by congress in the first place). The FED is only going to bailout their own shareholders.
More...

The Fed is effectively part of the government, hence I disagree the government had nothing to do with it.
 
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