E-piphany

Okay, let’s say this plainly: anyone who thought that the bailout of Fannie and Freddie would stop at the cap the Treasury originally put on them, that after pouring $111bln into them the government would just walk away and let them fail if losses were greater than that, was living in a fantasy world to begin with. From the moment of the original bailout, it was clear that whether the institutions were going to be phased out or sized up, they weren’t going to be allowed to default.

It was also clear that since FNM and FRE issued some enormous one-year obligations when they regained access to the credit markets, the first real concerns would come when those debts were being rolled over along with the loads of other debt that the GSEs typically need to roll. We’re what, 15 months or so from the bailout, so the timing isn’t particularly shocking. A trifle later than I expected, actually.

That’s why it is all the more amazing that Secretary Geithner’s Treasury waited until Christmas Eve, late in the day, to announce that the government’s support for FNM and FRE would be henceforth uncapped (which is as close to an explicit guarantee as you can get – in theory the Treasury didn’t say they would cover any debt, just that they could cover any debt). Currently, the government has committed up to $200bln per entity (double the original commitment), and has injected about a quarter of that amount…so uncapping it is probably irrelevant. So why do it on one of the least-watched news days of the year? It just smells funny.

What is more important, actually is that the Treasury also softened the requirement that the GSEs start shrinking their mortgage portfolios next year by 10% per year (the 10% in 2010 now applies to $900 bln per entity rather than their actual portfolios of around $800bln each, so voila! they’re already there). This is a concern because these enterprises are much much much too big to fail and their subsidized existence skews the functioning of the mortgage marketplace. They need to be dramatically reduced in size, and backing away from that commitment only one year after it was made looks to me like the first step to removing that requirement altogether. And that would be a bad thing.

All of this needed to be done by year-end or the Treasury would lose their authority to make these changes without Congressional approval, but…there are a lot of other days that would have made the announcement seem less cloak-and-daggerish. What is it they always say on “Law & Order”? Something about the perp displaying a “consciousness of guilt?”

Credit should be given to David Kotok at Cumberland Advisors for actually being around to read the Treasury’s release and to write a post on Christmas Day to make sure this didn’t completely slip under the radar.