Friday, July 11, 2008
Fabian: Butch, whose bond yield is this?
Butch: It's a stock price, baby.
Fabian: Whose stock price is this?
Fabian: Who's Fred?
Butch: Fred's dead, baby, Fred's dead
-Pulp Fiction, alternative universe financial version
Now, let Macro Man say right at the outset that he is not intimately acquainted with Freddie and Fannie's balance sheets, and does not run his own models on their capital adequacy/requirements. That having been said, he's been reading stories of their misadventures for years, and could see with his own eyes how they aggressively expanded their balance sheets even as the US housing bubble was inflating and deflating. Moreover, the graph of the share price, which is presumably set by people more intimately familiar with the firm's financial standing than your humble scribe, conveys only one message: Fred's dead, baby, Fred's dead. The similarity to the stock chart of Bear Stearns (and Northern Rock, and Bradford and Bingley) is telling.
So the question then becomes what to do with Freddie and Fannie. Clearly, allowing them to die is a non-starter, as it would eviscerate the financial system and send the housing market into a full-fledged depression. That's obviously politically unpalatable, particularly in an election year. Government intervention would appear inevitable, therefore. Of course, if the Feds step in, private sector shareholders should be left with a goose egg. As a US taxpayer, Macro Man can assure you that he has little interest in paying to clean up someone else's mess, only to see them reap all the rewards after the fact. The NY Times suggests that plans are being readied for some sort of nationalization.
The more interesting question is what becomes of Fannie and Freddie's bonds? The rapscallion in Macro Man would like to see substantial losses for the bondholders as well. After all, people like Voldemort and the Russkies have been buying a helluva lot of Agency bonds with the proceeds of their FX piss-taking. If globalization has brought about of economic realpolitik, it would be refreshing to see SAFE, CBR, et al hit with hundreds of billions of losses as a "reward" for their currency manipulation.
Obviously (and sadly), that's not going to happen. Somehow, the quasi-government guarantee on Agencies will likely to become more formalized. The implication is that 1) the stock of US Treasury debt may be about to go up- by a lot 2) The spread between Agency and Treasury bonds could converge to zero 3) Irritatingly, the FX reserve managers will receive a windfall proceed from their piss-taking. Come on, Hank, grow a pair and tell 'em to quit taking the piss or they'll get nowt for their Agencies!
So we're left with the seemingly ironic scenario wherein the lower Freddie's share price goes, the higher its bonds could/should trade relative to Treasuries. So far, that's not been the case, but one wonders if the fixed income RV traders will start making those bets. Of course, another way to play a Federal assumption of Agency debt would be to simply sell Treasuries. US CDS have ticked wider this morning on the notion that the stock of UST is about to get a lot bigger.
Finally, a word on oil. Macro Man has some sympathy for the notion that a lot of the oil price rise over the past few years has been demand driven, and has met with an inadequate supply response. And he's not totally convinced by the spec-bashing of a guy like Michael Masters, who happens to be long a lot of stocks in a crappy industry (airlines) that is badly hit by higher oil prices.
But still. Perhaps those who say that fundamental supply and demand are the only driver of price can tell the rest of us how that dynamic changed between 19:12 and 19:25 London time last night to generate a four buck rally in the price of crude?