Monday, September 8, 2008

Hank's Bazooka Is A Boomerang

FRE/FNM bonds are now backed by the Treasury, so the yields of FNM/FRE should converge to those of comparable treasuries. Does anyone really believe that a future McCain or Obama administration are going to see things the way that Hank sees them?

Let's face it: House prices aren't even close to stabilizing. The taxpayer payout on FRE/FNM bonds is going to be substantial.

In future years, when taxpayers are still paying for the nationalization of FRE/FNM, it is going to look VERY attractive to demand that bond holders take, say, a 10% haircut. This move will be a politically expedient method to save an enormous amount of money: On $5 trillion dollars, $500 billion dollars will be generated without raising taxes or cutting spending.

Therefore, the best bet for current investors in FRE/FNM bonds is to sell them and buy treasuries now, while the yields are close. Naturally, since many bond holders will recognize this strategy, the correct tactic is to sell first and not buy any more bonds until the interest rate reflects the risk that future payments are likely to be cut. This will drive the bond rates up, mortgage rates up, and will negate the very thing that Hank is trying to accomplish.

It will be a horrific mess once the markets realize this fact. Fasten your seatbelts.

1 comment:

berto said...

Yes, dump F+F bonds, but buy Treasuries at what duration? While you're being cautious, why not go short. Watch for a steepening yield curve.