The companies rely heavily on overseas investment, often up to two-thirds of each new multi-billion-dollar note offering, to help pare funding costs and keep mortgage rates low.
But foreign central banks have dumped nearly $11 billion (Dh40.3bn) from their record holdings of this debt in four weeks, to $975bn, and will not return in force before it is clear if – and how – the government will back Fannie and Freddie, some analysts say.
President Bush has already approved the means by which Treasury and the Federal Reserve could bolster these two companies, which both reported greater-than-expected quarterly losses and steps to beef up capital.
Fannie and Freddie said they aren’t seeking that support and Treasury Secretary Paulson said he isn’t offering.
The bonds these companies issue in the $4.5 trillion agency MBS market are near or worse than the weakest levels, set in March before the government engineered the sale of failing Bear Stearns to JPMorgan.
“People are concerned about whether there’s a bailout that’s going to be coming from the US, so it would be logical to see foreign investors pull out of agency paper,” said Kevin Chau, forex analyst at IDEAglobal in New York.
“They don’t know whether the US is going to be committed to supporting the GSEs, and if they are going to support them, by what methods are they going to support them.”
A $30 BILLION SOLUTION?
Overseas investors took an atypical back seat in Fannie Mae’s three-year note sale this week. Central banks bought just 37 per cent of the $3.bn issue, down from 56 per cent in May’s $4bn offering of the same maturity. Asia accounts took just 22 per cent of the notes, down from 42 per cent in May.
Freddie Mac will soon also test overseas interest in the $3trn agency debenture sector. It announces August note funding plans on Monday.
“Most fixed income investors to whom we have spoken believe that a capital infusion by the government into Freddie and Fannie is a pre-requisite for turning sentiment around in mortgage-backed securities and, by extension, in the broader fixed income markets,” Barclays Capital analysts Rajiv Setia and Philip Ling wrote in a report.
A $10bn to $15bn infusion for each government-sponsored enterprise (GSE) is seen doing the trick. “The longer the debate drags on, the more tentative foreign interest is likely to become. Even though the GSEs are adequately capitalised, investor confidence has been shaken,” the analysts wrote.
“A slowdown in international investor interest remains the major risk factor for agency spreads, in our view.”
SOME SEEK EXTREME MAKEOVER
As mortgage bonds trade poorly while investors wait for good news on Fannie and Freddie capital, US mortgage rates have climbed to their highest levels in a year.
It took severe measures to restore investor confidence at various times during the year.
When markets were turbulent in March during the Bear Stearns crisis, Fannie’s and Freddie’s regulator lifted limits on their mortgage portfolios and lowered the amount of capital they needed to hold. This signalled that the GSEs would be big mortgage buyers, helping stabilise housing and the markets.
In June, foreign investment in agencies showed none of the stress seen lately, rising to $31.46bn from $28.16bn in May, Treasury data on Friday showed. In July, the Fed and Treasury agreed to backstop the two companies if needed, and Bush approved the measures as part of a new housing act on July 31.
However, the initial optimism about the plan has been doused by concern about the government’s follow-through.
“There’s a crisis of confidence” in the two companies, and “we’re likely to see renewed flows into Treasuries and perhaps some high-quality US corporates” instead, said Michael Woolfolk, senior currency strategist at Bank of New York Mellon. The US has become dependent on foreign investors buying dollar-denominated securities, lowering borrowing costs for various consumer loans and stimulating the economy.
But with housing in its biggest slump since the Great Depression, and banks burned by record foreclosures making it harder to get loans, more extreme steps are needed to assure investors.
“It would take something dramatic for there to be a material improvement in the confidence necessary to bring foreign investment back to these agencies at the levels we’ve become used to,” Woolfolk said. “There is the hope that’s held out by some for a magic bullet, and that could take the form of a sizable infusion of capital or perhaps a complete rethink of restructuring both of these GSEs,” he said.
“If not the cash injection, then [we need] an overhaul.” (Reuters)