GSEs Debts - Important View

I partially agree with Encik Wan's posting on the demise for US Treasuries. Following the developments with respect to Fannie & Freddie, prices of treasury coupon securities have declined modestly in overseas trading. The yield on the benchmark 2year note has climbed a basis point to 2.60 percent. The yield on the benchmark 5 year note has increased by 2 basis points to 3.30 percent. The yield on the 10 year note is also up 2 basis points to 3.98 percent and the yield on the Long Bond is higher by 1 basis point at 4.55 percent.The 2 year/10 year spread has flattened a basis point to 138 basis points.

The Treasury (Paulson) has offered to place the GSEs on financial life support. There is a multitude of problems which the system confronts. The banking system is still starved for capital and is likely to be for some time. Risk aversion is ascendant and the cowboy philosophy that reigned supreme has been tamed.

Fannie & Freddie would look to be the biggest obstacle, and the fact that the Treasury and Fed are dealing head-on with it is the positive side from the developments. That is reflected in the USD movements. The bad side, which many have not looked at, is debt by US government sponsored enterprises (GSEs). Debt issued by GSEs have always tracked US Treasuries closely because investors regarded them as being backed by US government.

It is imperative that the lawmakers quickly pass laws to save Fannie & Freddie because ANY hiccups may cause a stampede in GSEs debt. To even have the possibility that GSEs debt may not be actually fully backed by the US government will cause a huge sell down in GSEs debt, and will plunge the USD to uncharted waters.

To give an example of how much GSEs are out there - last year China bought US66bn in GSEs debt and only US12bn in US Treasuries. Russia bought US34bn of GSEs debt and SOLD US22bn of US Treasuries. So, the Treasury and Fed have to quickly rescue Fannie & Freddie with absolutely no hiccups in congress.

Anything less than that will see bond prices of GSEs debt falling like a rock and USD being pummeled by at least 10%-20%. While that is the "potential bad news", we should remember that Paulson and Bernanke also know that - hence its a postulation at best now, let no one go and do something silly like NOT fully rescuing Fannie & Freddie.

p/s photos: Leila Tong Ling