Yves Smith writes at Naked Capitalism Tuesday that a pretty significant shift is taking place — Treasuries are looking similar to senior debt of the GSEs. From her post:
As we indicated, a deterioration in Treasuries was the likely outcome of affirming the implied Federal backing of Fannie and Freddie debt. And as we said, we might have been able to persuade our friendly creditors, meaning foreign central banks who also own a lot of Treasuries, that they’d likely be no worse off from a restructuring of GSE debt that involved a modest haircut (or equivalent via a reduction in yield). Too late for that now.
Too late, because U.S. Treasury CDS contracts increased to new records Tuesday, at least for the 10 year. Which implies that GSE debt is less likely to get restructured; which, if you believe the GSEs are generally solvent and liquid, is likely to be of little significance. It’s worth nothing, as well, that really only the long Treasuries are showing the trending Smith is talking about. And while I’m not nearly as knowledgeable in bond market analysis as Yves is (in either comparative or real terms), frankly I don’t know that seeing long bond investors move Treasuries closer to GSE senior debt is likely to be the ominous trend that she’s making it out to be. For one thing, the specter of quickening inflation is out there in force — which alone would probably be enough to explain deterioration in long Treasuries. But even if we grant that some of the movement is due to investors’ growing concern about the U.S. balance sheet, I’d argue that the government has always stood behind the GSEs from a debt perspective; moving closer to making that explicit is one thing, while actually making it explicit is another entirely. I’m willing to admit, as well, that I don’t understand the financial press’ consistent suggestion that CDS spreads are more indicative of some elusive “market truth” than those unclean masses that tend to invest in equity positions; CDS investors can over and underreact to market news as well, last time I checked. And while I don’t have faith in many things, I think based on my discussions with key sources that there is likely little desire on Capitol Hill, or even among regulators and policymakers for that matter, to see the GSEs nationalized. I also happen to think the hullaballoo over the GSEs liquidity position is likely being dramatically overstated. Any possible capital squeezes at either enterprise are likely just too far out into the future at this point, with too many variables in between now and that time — and I’d tend to agree with the analysis from Jim Vogel at FTN Financial, who suggested that even in a tough market, capital adequacy only becomes an issue four quarters from now. A lot can happen in a year. Everyone on the equity side of the fence seems to be forgetting that the GSEs are liquid as hell, too; and I mean really, really liquid. Liquidity on top of liquidity, even. And we’ve already seen that debt investors heartily endorse funding both companies, too. Which makes the endless discussion of a lack of liquidity somewhat tough to listen to with a straight face. Like I said, I’m not a bond market expert — I’m a housing and collateral risk guy at heart, after all — but if I’m right, you’ll have to start think about what it was like investing in Citi in the 1990s. Didn’t many of those betting on C at that time get laughed off the basketball court, only to retire off the gains they made? Disclosure: part of the unwashed masses and long FRE common shares.
