Treasury’s Elusive Guarantee of Fannie/Freddie Debt and MBS

The Treasury doesn’t actually guarantee any Fannie Mae (FNM) and Freddie Mac (FRE) debt and MBS. They simply agreed to provide up to $100B for each to prevent the GSEs’ net worth from falling below zero. This support, but non-guarantee of the debt and MBS has the foreign financial institutions confused and concerned. Treasury Undersecretary for International Affairs David McCormick phoned Japanese banks and insurance companies to explain the program.

Paulson thought he could create the illusion of a Treasury guarantee without actually committing the government. Foreigners are having trouble accepting that the debt of strong GSEs can stand on its own. The foreigners appear to be also questioning Paulson on what happens after he leaves.

To quell fairs and confusion, the Treasury issued “Frequently Asked Questions: Treasury Senior Preferred Stock Purchase Agreement” on Thursday. The main theme is that it would be dishonorable for Congress or the next Administration to change the agreement Paulson put in place. However, it states that any contract can be changed if both parties agree. Since both the Conservator and the Treasury are both part of the executive branch, the White House can change anything at will.

The FAQ states that senior debt, subordinated debt and MBS issued or maturing after December 2009 will be protected by the Treasury’s senior preferred stock purchase agreement. The agreement does not end specifically in December 2009. This adds further confusion in that the Treasury is claiming that the agreement extends beyond the authority Congress granted Treasury for unlimited funding of the GSEs.

Even if foreigners can be convinced that the Treasury “backstop” is good enough, no one can discount the political risk. A careful reading of the FAQ lends no comfort on the political front.

Wouldn’t it have been far simpler for the Treasury to have traded reinsurance of GSE debt for warrants? It is not surprising that foreigners differentiate between protecting net worth and protecting debt.

Related Posts: Trading Patterns in Fannie/Freddie Common Stocks, Valuing Fannie and Freddie after 79.9% Dilution, Investing (Gambling) in Fannie Mae Preferreds

Disclosure: Author is long FNM and FRE.

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