From the July 17th issue of “The Economist
“Nationalization . . . would bring the whole of Fannie’s and Freddie’s debt onto the federal government’s balance sheet. In terms of book-keeping this would almost double the public debt, but that is rather misleading. It would hardly be like issuing $5.2 trillion of new Treasury bonds, because Fannie’s and Freddie’s debt is backed by real assets. Nevertheless, the fear [is] that the taxpayer may have to absorb the GSEs’ debt . . . . That suggests yet another irony; the debt of the GSEs has been trading as if it were guaranteed by the American government, but the debt of the government was not trading as if Uncle Sam had guaranteed that of the GSEs.”
Voltron says: This irony (or paradox) has been resolved: the GSE debt was priced correctly and government debt was priced incorrectly. The government’s intent in bailing out the GSEs was to raise the value of GSE debt (decrease borrowing costs) but since that proves that government debt was mispriced; it is government debt prices that will adjust. In fact, this has started happening already. The Treasury’s actions will do nothing to fix the housing bust. It will just make the budget deficit worse. It will collapse the dollar and cause inflation. It will drive banks holding GSE equity into the arms of the woefully undercapitalized FDIC. If fannie and Freddie couldn’t make money with all of their “implicit guarantees” and tax advantages and everything else . . . how are regular banks supposedly profitable? Of course there’s optimism in the market that the Fed and Treasury Dept are taking decisive action, but the fact that they are doing it now is evidence that the problem is much much worse than they were previously willing to admit. The government is bent on doubling down again and again until the election/inauguration.
More background and analysis here.