In case you’re fortunate enough not to have noticed, the spreads on Fannie and Freddie debt over Treasuries have widened to record levels in recent weeks. This isn’t supposed to happen: Fannie and Freddie debt is now guaranteed by the full faith and credit of the blahblah. In theory, Fannie and Freddie debt is no riskier than Treasuries.
(Why do the spreads matter? Because they will drive mortgage rates up, further clobbering the housing market, prolonging the crash, etc.)
Why are Fannie and Freddie spreads widening? We don’t know. But here are a couple of theories we’ve heard. The first is hard to believe. The second is terrifying.
- The market doesn’t believe that the debt is actually guaranteed or that the guarantee will be revoked by an Obama or McCain administration. Come on, people. No chance. This is bailout nation. If this is really why spreads are widening, there’s a great trade here.
- THERE IS NO MONEY LEFT IN THE WORLD TO BUY ANYTHING. This is J. Kyle Bass’s theory. Kyle runs the uber-bearish Hayman Advisors, whose quarterly letter scared the living sh** out of us.
Why did Iceland jack up interest rates to 18% a few days ago? Because it desperately needs to prop up its sagging currency. And apparently no one was willing to provide capital for anything less than 18%. Yes, Iceland is bankrupt, so folks are understandably reluctant to lend money to it. But it wasn’t long ago that there was so much capital sloshing around the world that even the bankrupt could borrow at a few BPs over Treasuries.
Wise folks have long wondered when China, Japan, and the rest of our creditors would wake up and stop sending us billions for free. True, the dollar is not yet collapsing like the krona. But if Hayman is right and the reason that the Fannie/Freddie spreads are so high is that our creditors just don’t have the money to give away anymore, then how long will it be before they shift their stinginess to Treasuries?