Too Big To Fail
The access to credit via the Treasury and Fed means the implicit guarantee on the GSEs’ debt is now explicit.
– Ian Shepherdson (subscription required), Chief US Economist, High Frequency Economics
Capitalism without failure is like religion without sin.
– Allan Meltzer (subscription required), Economist
The failure of Fannie Mae and Freddie Mac would be so apocalyptic that it absolutely will not be allowed to happen:
- Fannie and Freddie own or guarantee $5 trillion in mortgages – about half the entire mortgage market (GSE Mortgage Market Share Chart). If they were unable to make good on their guarantees, you would see a collapse in the massive mortgage market that would send tidal waves through global financial markets.
- Fannie and Freddie have about $1.6 trillion in outstanding debt that is held by financial institutions and central banks the world over. A failure of Fannie and Freddie and their consequent inability to pay their debts would mean hits throughout the global financial system.
- Fannie and Freddie’s purchases of mortgages from banks is pretty much the only thing keeping the housing market functioning at all these days. Were they unable to continue operations, the US housing market would come to a standstill and panic would ensue.
Therefore, combined with the complete lack of principle in Washington these days, Fannie and Freddie will be backstopped regardless of cost.
Really that’s implicit in actions taken yesterday (Sunday) by The Treasury and Federal Reserve. The Treasury announced they will be expanding Fannie and Freddie’s credit lines and might potentially take an equity stake in them (Treasury Press Release). The Fed announced they will allow Fannie and Freddie to borrow whatever they need above and beyond the expanded credit line from Treasury (Fed Press Release). On this, also see the WSJ’s front page article today “Treasury And Fed Pledge Aid For Ailing Mortgage Giants” (subscription required).
Everybody seemed to know that the government would step in to make explicit their backing of Fannie and Freddie. Had they not I think we would have seen a crushing selloff this morning.
As it was, markets rallied at the open on news of the government backstop, but the gains didn’t hold and markets have drifted lower over the course of the day (S&P Intraday Chart).
I’ve been hoping for a capitulation day: a brutal selloff accompanied by a spike in fear as measured by the VIX (see “Getting Close To A Good (Short Term) Buying Opportunity”, Top Gun FP, Wednesday July 2). In a lot of ways, Friday qualified with the Dow down more than 200 points at the low and a spike in the VIX over 29. The S&P got as low as 1225 on Friday – it’s found support there today as well.
We’re seeing some more weakness heading into the close today. I feel like the opportunity I’ve been waiting for is here. I might wait a little bit but I think I’ll put on some positions for a trade this afternoon.