GSE Bailout Unlikely to Help with Housing Crisis

I’ve been swamped with MBA work, so I haven’t had much time to post to my blog.  But with recent awe-inspiring market fireworks, I view a divergence from statistics and finance as a welcomed event.

By now you’ve all heard the news: the US government took control of Fannie Mae (FNM) and Freddie Mac (FRE).  Miraculously, just a few days after Bill Gross, Director at PIMCO, pleaded for a housing bailout in his September Investment Outlook, Treasury Secretary Henry Paulson colluded with Wall Street moguls to formulate a government take over.  The deal was finalized over the first weekend in September.

No surprise here.  Even a lowly grad-school student, such as myself, was able to ring the early warning buzzer almost two months prior to the bailout.  On July 14th I asserted that a “fully-fledged bailout of Fannie and Freddie could be in the works.”  Though it’s nice to see my conviction realized, I’d feel a lot better if I had picked up some equity shorts.  Even my finance professor sold a few shares around $15, and covered at $3!  Not sure how I missed the boat on that one… but I digress.

Unfortunately, the GSE bailout was more or less necessary; a collapse of Fannie and Freddie would have eviscerated an already ailing housing market.  What wasn't necessary was the means by which Paulson took control of the GSEs.  Fannie and Freddie were wrongly placed into a conservatorship, thereby bailing out the People’s Bank of China (perhaps the largest market piss-taker).  Certainly, no one coerced the PBOC into buying over $50B in agency debt every month.  Obviously, China conveniently ignored the fact that yield premium over treasuries is not “free.”  It's painful to see the PBOC rewarded for artificially depressing the Yuan -- especially at the expense of the US taxpayer!

Unfortunately, I have to admit that the concept of “fair play” doesn’t hold true at home either.  Bill Gross (read: US citizen, multi-millionaire, and bond-investor extraordinaire) has also been saved by the US taxpayer. 

As manager of PIMCO’s $132B Total Return Fund, Bill must have smiled when the news of the government’s seizure of Fannie and Freddie hit the wires (though I wouldn’t be surprised if he was already aware of what was about to transpire).  On that day, the Total Return Fund posted its strongest day ever as prices of mortgage-backed securities rose sharply.  I guess Bill won’t have to worry about losing out on the “high life” or giving up his mansion in Newport Beach.

Anyway, now that foreign Central Banks (and Bill Gross) have been saved by the US taxpayer, it’s time to focus on the implications.

The intention of the bailout was to support the US housing market, but I think there’s a strong possibility that the takeover will back-fire.  Immediately following Paulson’s announcement, investors’ knee-jerk reaction was to push down the end of the yield curve.  But, in the longer term, rates may end up moving in the opposite direction.

It seems likely that the US government will soon be forced to buy illiquid mortgage backed securities in the open market to finance FNM and FRE.  To help fund the capital infusion and buy MBS issued by the two agencies, the government will issue debt, thereby adding to the Treasury supply.  This will end up pushing mortgage rates higher, as mortgage rates are priced off benchmark Treasury yields – exactly the opposite of what Paulson wants.

Thus far, the Treasury has committed up to $200B for the bailout, but as of yet, analysts have been reluctant to forecast the amount of Treasury issuance required to cover the cost.  If past history is any indicator of future events, one thing is for certain: $200B will end up being a floor, not a ceiling.

And with that, it’s time to get back to my class work.  After all, someone will have to be making a healthy income to help fund the US government’s newly-acquired debt burden!

Comments

[Sing Expat:]

What housing crisis? Oh, you mean the one where houses are far too expensive? That one? Or the bubble one where people lost their minds and let Greenspan, Bernanke and Wall Street steal trillions of dollars?

If you want to end the housing crisis, let prices return to affordable levels. The endless tripe about saving house prices is sickening. Where are the headlines to help gold or oil bulls? What about helping out gamblers (whoops, Paulson is already doing that!)?

Get stuffed with you BS about house prices. They are too high and need to fall another 30%. Then, maybe, we can start rebuilding the economy on a sound base.

2008 Sep 14 09:12 PM

[User 268924:]

I’m sure you are smart enough to be pissed about this housing bailout crap rather than just doing the sheep to the slaughter thing that most of this country is doing. Dave and some others have put together a plan to keep us from eating this 700 billion worth of other peoples mistakes. The only way it is going to work though is if enough people email congressmen, senators, reps, and anybody else you can think of. It’ll only take a second to keep our grandchildren out of an ocean of debt not to mention it will be helping this country take a hard right away from socialism. Don’t be lazy, take a second to do this. Not many people realize the implications of the housing bailout beyond the immediate economic views. The country won’t crash without this bailout, this plan can work but only if Congress truly believes that we’re going to take them down a notch if they don’t get on the ball.

You can read and hear about it here:
www.daveramsey.com/tdr...

Seriously, take a second to send an email, and forward this along.

2008 Sep 24 03:02 PM