GSE Takeaways

September 8, 2008

The GSE “backstop” is now in place, and I will cut to the chase.

The key takeaways are that in terms of capital infusion into the entities, the Treasury has put itself ahead of the equity and preferred holders, whose dividends are eliminated and stock is diluted. The effect of this will weaken smaller or regional banks with these holdings, opening the way for vulture plays.  The number infused would be $100 billion in each company (over time) which is very close to the number I put forth months ago.

The Treasury will start reducing the retained portfolio “starting in 2010″, which is a meaningless “talk big” policy. In the meanwhile the GSEs may expand their portfolios without capital constraint. The big story is that US Treasury steps in as a backstop buyer of agency mortgage backed securities. Voila, new capital from these holdings materializes overnight. Depending on the activity here and the level they buy at, this represents socialization of losses.

This is a strange duck as the US Treasury will need to borrow (from foreigners) in the Treasury market in order to support foreigner’s holdings of agencies. The logical question to ask once again: will foreigner’s and FCBs provide sufficient and additional Ponzi finance to finance the Treasury’s intervention into this market? And will they also continue to support the agency mortgage market to boot? The Federal Reserve is no where mentioned here, with the Trillion question being, do they monetize?

Incidentally, the current state of the US mortgage generally looks like this. Last week, the Mortgage Bankers Association reported a fresh surge in delinquencies and foreclosures during the second quarter, indicating that deterioration in the housing market is ongoing. A record 9.16% of U.S. mortgages were in delinquency (6.41%) or foreclosure (2.75%) as of June 30. This figure will likely be even worse in the third quarter report.

Treasury takes over management, and the final fate will be passed on to the new administration, where presumably under McCain it will be privatized Alexander Hamilton style, and under Obama it will be nationalized. Lobbying (from the GSEs) will be halted immediately, which is carte blanche for other “players” to step into the breach and buy off legislators and the executive branch.

The wildcard is the effect of this on Treasury yields. The effect on the credit of the US government should be negative. My gut is that Treasuries are to be shorted, with the timing still a bit up in the air. I will put that forth in more detail on the Actionable side.

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