Years ago, before Fannie Mae (FNM) and Freddie Mac (FRE) became black holes to the tune of $400 billion, there was some debate about what kind of guarantee they had from the government. Was it full? Implicit? Explicit?
The question was left deliberately vague.
Fast-forward to now, the real surprise is not that they’ve been bailed out to such a mindblowing extent, it’s that all of the major banks turned out to be GSEs as well. Citigroup (C), Bank of America (BAC), AIG etc; they all enjoyed the same implicit guarantee from the government. Just nobody knew it. Or maybe they did know it, but the assumption went unspoken.
Now it’s been made explicit, however.
We are gratified to see that Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke take our suggestion of several weeks ago on CNBC not to allow the TARP banks to repay the government debt until they prove the ability to function in the debt markets without reliance upon a government guarantee.
Washington has indeed fixed the solvency problems of the large zombie banks — not with additional capital or stress tests, as many of us seem to think. Rather, the banks have been stabilised by turning them into GSEs via FDIC guarantees on their debt. Those banks which can end their dependence on federal guarantees will be the visible winners in the post stress test market, and valuations and spreads will reflect this divergence between zombies and viable private banks.
Seen from this perspective, Chrysler, General Motors (NYSE:GM) and the large banks are GSEs rather than private companies, parestatales as they know them in Mexico. To talk about a rally in the equity of large US financials seems truly ridiculous, at least to us, especially true when you look at how the public sector subsidies being applied to the banks have distorted their financial statements.
Maybe by the end of next year, when we know which banks can or cannot shed the need for government subsidies, then we can talk about investible equity in these GSEs. To that point, turning Bank of America (NYES:BAC), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) into GSEs was just the first battle, Vol. II of the Lord of the Rings, to use another cinematic metaphor. Next comes dealing with the dysfunction in the non-bank market for securitization and financing, the real battle to save the US economy from a truly dreadful year-end 2009 and beyond.
And of course, that worked out so well the first time. What coul go wrong this time around?
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