What default? FDIC RMBS powers up bond market

The Federal Deposit Insurance Corp. is moving ahead with a residential mortgage-backed securitization of failed bank assets despite uncertainty about the implied credit ratings. Normally, such a deal would carry the equivalent of a triple-A rating as the federal government backs the bond guarantee, as did a similar deal last year. However, if the U.S. sovereign rating is downgraded, the country cannot carry debt at a higher rating. This means the FDIC deals, and others before it, instantly get downgraded as well. And so do Ginnie Mae, Fannie Mae and Freddie Mac bonds. The markets are responding to the possibility. “Several articles in the past few days have noted the slowdown in bond issuance related to uncertainty over the resolution of the U.S. government debt ceiling,” said Standard & Poor’s in a note Wednesday. “With the uncertain timing of a possible debt agreement, we could start to see effects on structured finance with a lag.” There also remains the potential of a downgrade even if a deal on the debt ceiling is reached. Credit ratings agencies may take note of the lengthy time it took for such a deal to be consummated — considering the impact to short-term debt as well — and downgrade based on slow reaction times. So considering the market conditions, why would the FDIC look to price the RMBS? One source likened it to buying a used car, where the collateral immediately decreases in value once the ink is dry on the deal. Well, to be sure, someone has to do something here. The FDIC and the arranger, the Royal Bank of Scotland, can’t comment on the record, with the latter citing Securities and Exchange Commission regulations. But it looks to be less than $400 million and made up mainly of Colonial Bank mortgages. I’m told this report from International Financing Review is an accurate summation. But with Federal Reserve‘s Maiden Lane II offerings sidelined, the message cannot be that America’s bond markets are closing for business in the shadow of potential downgrades. America needs to show that it is not beholden to credit ratings agencies. There is a need the CRAs fill, but it can no longer be at the expense of the nation’s ability to effectively operate secondary markets. From this perspective, it is not a question of default and the ripple effect. This is a question of unnecessarily stifling liquidity. That is the political end game for the markets. And the FDIC is right not to kowtow. Write to Jacob Gaffney. Follow him on Twitter @jacobgaffney.