Lockhart’s Remarks Confuse GSE Debt, MBS Investors

(update 1; edited sections for clarity) Investors are clearly paying attention to what Federal Housing Finance Agency director James Lockhart says. Unfortunately, it’s not been all that easy for investors to decipher his latest set of remarks. In testimony Thursday afternoon to the Senate Banking Committee, Lockhart said “the conservatorship and the access to credit from the U.S. Treasury provide an explicit guarantee to existing and future debt holders of Fannie Mae and Freddie Mac.” The choice of words — an explicit guarantee — immediately sent risk premiums tighter on debt securities issued by both Fannie Mae (FNM) and Freddie Mac (FRE), as investors digested apparently news that the GSEs would be nationalized. The Wall Street Journal reported that risk premiums tightened as much as 7 basis points over Treasuries on benchmark two-year notes. The published remarks of Lockhart’s speech however, replaced the word “explicit” with the word “effective,” leading risk premiums to swing in the other direction, with Fannie’s two-year note closing 2 basis points wider to Treasuries. Bloomberg reported that yields on Fannie’s current-coupon 30-year fixed-rate mortgage securities compared with 10-year Treasuries rose 12 basis points to 188 basis points as of 3:05 pm EST on Thursday, as well. Friday morning, investors were still grappling with Lockhart’s choice of words, and asking: what’s the difference between an effective and an explicit guarantee? The difference probably is as simple as degrees — an effective guarantee being one degree away from direct government funding. Formal nationalization of the GSEs would require an act of Congress, but the U.S. Treasury’s decision to place both GSEs into conservatorship under the FHFA means that each may offer up to $100 billion in senior preferred stock directly to the U.S. Treasury. Debt and MBS investors, however, still remain unsure if the debt of the agencies will carry the full faith and credit of the U.S. government. The FDIC recently cut its so-called risk weighting for banks on Fannie and Freddie’s credit claims to 10 percent from 20 percent — but not to zero percent — a move that various financial press suggested would potentially stimulate sagging demand for agency MBS. But the agency also recently provided an explicit government guarantee for new bank debt, leading investors out of MBS and GSE debt markets in recent weeks. Read Lockhart’s transcribed remarks >> Disclosure: The author held no positions in any of the stocks mentioned when this story was published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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