Monday, July 14, 2008

Treasury and Fed back Fannie and Freddie

The treasury is increasing its lines of credit to the two mortgage giants. Also saying govt might take an equity stake in the company, if the companies request. Here is my take:

a) Bondholders: Definitely a plus for the bondholders. Fannie Mae and Freddie Mac debt is now treasury debt. This is moral hazard.

b) Equityholders: Isn't this an admission that the companies are undercapitalized, and might have difficulty raising money on their own in the debt market. If the Bear Sterns precedent is any guide, when Paulson forced Bear's board to accept $2, shouldn't the existing shareholders bail out - now.

There are so many people short these stocks that a short covering rally could easily double them in a day. If the stocks stabilize at $20-$25, raising capital at that price is also possible. This is a situation where the current stock price determines the fundamentals, not the other way round. These stocks can go to $0 and they can also go to $25.

Logic will say they should go to 0 - but logic has its limitations these days. I think that Paulson's idea on how to avoid moral hazard in Bear Sterns is going to come back and bite him someday.

c) Treasury bonds: Suddenly, there are many more treasury bonds out there. So yields should up. Still, Fannie and Freddie were always assumed to have govt backing. Don't think it should be a stomach churning spread widening.

d) Dollar: Do you really want to hold the dollar? This is not the last govt bailout. I think the real risk now is any unorderly fall in the value of the dollar. At some point, people will revolt against the printing machine.

e) Oil: If dollar is at risk of going down, oil is at risk of going up.

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