OK, so the Fed is planning to buy obligations of the GSEs — as well as securities guaranteed by the GSEs. This is in an effort to lower spreads. The Fed will in effect pay for these purchases by having the Treasury issue U.S. government debt.
But the GSEs have been nationalized. Their obligations are already U.S. government debt. What’s going on here?
It’s true, as the Fed’s statement says, that
Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late.
But that’s presumably because the Bush administration, weirdly, has refused to declare that GSE debt is backed by the full faith and credit of the US government. Why not just make that declaration, turning GSE debt into Treasury obligations, rather than stuff the obligations onto the balance sheet of the Federal Reserve?
Is this some kind of strange political game? Is there something else going on here? Inquiring minds want to know.
Thursday, November 27, 2008
I used to think that if the government only made the GSE obligations full faith and credit (FFC) obligations the remaining problems in the conventional mortgage market would go away. Paul Krugman still thinks it:
He is of course wrong. The Goldman Sachs obligation is full faith and credit of the US Treasury - and trades at an irrationally wide spread. Nobody has given a plausible explanation (except lack of trust in the government) as to why the spread on FDIC paper issued by Goldies but backed by the full faith and credit of the US Treasury is 200 bps.
For once the world is even stranger than Paul Krugman thought and stranger than his models.
Now there is an implication here - which is if the market will not believe that something is full faith and credit of the US Government then the government should buy it, issue treasuries and make an arbitrage profit. There is a free lunch here. Of course this mucks government accounting around (the debts wind up on balance sheet of the government rather than just contingent). However it does not change the economics from the government perspective.
And in the process we go from the government buying the troubled assets of financial institutions to the government buying the guaranteed liabilities of financial institutions.
Posted by John Hempton at 7:09 AM
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