GSE Bailout

The press is full of reports around a leak that the government will bail out the GSE's this weekend. We will see. An interesting coverage is the interview of Bill Gross on CNBC. Something tells me Gross is behind some of the ideas.

What is interesting is that he is talking about a convertible bond that would protect the equity. Of course Bonds are protected as well. Equity is worth $8B across Fannie and Freddie while the bonds are worth close to $5T (yet T) and the bond holders are large entities (like Gross' PIMCO) and the Chinese. Wiping out equity would be a symbolic move. Which is why it could go either way.

Obviously this bailout justification is that financial stability comes first in the US. The taxpayer will pick up the tab and the paper presses will run, creating some monetary pressure.

This is in contrast to the recent Trichet announcements (head of ECB) who, while keeping rates steady (and high) has proclaimed that "financial stability will not replace price stability". In essence Paulson, Bernanke et al are doing exactly the opposite. Financial stability first, price stability second.

There is the obvious criticism of moral hazard, it is surreal to hear the politicos talk tough in conventions when bailout nation is in full swing. The losses are socialized across the masses for the benefit of the few in the financial system. Hey I am not complaining, but the hypocrisy is kind of overwhelming.

On the other hand for all the moral integrity that Trichet is displaying, I am not sure it will play out nicely.

If in a deflationary environment, with monetary volumes (M4) going down, a high rate and a financial meltdown compound downward pressures on the economy in a negative spiral. You have NO financial stability and NO price stability. On the other hand the US starts with financial stability, unleashing the printing presses to bailout the GSEs and adding inflationary pressures in a deflationary environment. In the end they may achieve financial stability AND price stability.

Time will tell. Does this backstop the crisis? I am not sure. Only if lending resumes in earnest with taxpayers paying for overpriced houses of the few, and price stability of housing assets in achieved will I believe the worse is behind us. Right, you can tell where I am at... In the short term if I had the financial cojones I would buy FNM equity. It is a bit of a toss but it is a high payout toss.


Marcf said…

and the new 'coverage' says that preferred shareholders will take a big haircut. That is banks apparently.

When you think about it one of the biggest engines of US debt (10T?) has just been nationalized.
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