Submitted by Mark J. Grant, author of Out of the Box,
President Obama said yesterday that he wouldn't support restoring FNMA and Freddie Mac to the status they enjoyed before the credit crisis, which let Fannie and Freddie make profits during good times, "knowing that if their bets went bad, taxpayers would be left holding the bag," the president said in remarks at a Phoenix, Arizona high school. "It was 'heads we win, tails you lose,' and it was wrong."
In my opinion this was a game changing speech. The implications loom large not just for property owners but for investors if there will not be any "implicitly guaranteed" Agencies. For home owners it is likely to mean that their cost of mortgage products will rise and perhaps significantly if this task is left totally to the private sector. I suspect that in times of trouble then no one will lend and the volatility in the housing sector will increase dramatically.
If some new Government Sponsored Enterprise (GSE) is going to back-stop mortgages then their debt will be added to the national debt like the debt of GNMA now so that America's debt to GDP ratio will be impacted negatively. Perhaps, though, this new Agency will just guarantee certain types of mortgages and there will be no issuance of debt which will be problematic for the bond markets. With the Treasury indicating that new issuance will be down about 31% and the Fed monetizing about 52% of all newly issued government/agency debt now there could well be an extreme shortage of available bonds. Prices may sky rocket once again and yields fall as demand, much of which is being forced by the Fed's current policies, far outstrips supply.
Then there is the question of what banks may be allowed to invest in which would change the dynamics not just of their portfolios but of their financial risk position. Is it to be that they can only buy Treasuries then or will it be that certain types of corporate bonds or private mortgage backed-bonds will be allowed? There is a can of worms in this answer without doubt.
Then there is the question of their preferred stock. One of the largest blunders, in my opinion, during the 2008/2009 financial crisis, was to stop paying the dividends on these securities. Not only did it cause huge financial harm for many banks, especially community banks, but it called into question the value of the "implicit guarantee" of the country. While whether it was legally correct is still in contention the moral compass decision, in my opinion, was just very wrong. In any event one wonders what the brilliant minds in Congress will do with this issue when called to task.
The possible lack of issuance may well change the functioning of the fixed income markets in a very real manner. It could cause a huge amount of compression against Treasuries in all the other sectors. Spreads may compress past anything than we have seen before as the lack of available bonds decreases by large margins. With the Fed handing out newly created money like there is no tomorrow; the results could be disturbing.
I leave you with one final thought this morning. Many Municipal bonds are now yielding, for only the second time in recent years, more than their relatively rated corporate bonds. I suggest you not only take notice of this but make a change in your strategy to account for this opportunity. It will not last long in my view and the play should prove to be beneficial.