A Treasury official's testimony before Congress has shaken investors' confidence in Fannie Mae and Freddie Mac - and increased the secondary marketing giants' borrowing costs.
In the wake of testimony Wednesday by Gary Gensler, undersecretary for domestic markets, Fannie's stock Thursday fell as much as 6%, to $58, before rebounding; it ended the day at $62.50, up 1.03%. Freddie's stock fell as much as 8%, to $42.75, before rebounding to $47, up 1.21%.
Meanwhile, the spreads, or differences in yield, between the government-sponsored enterprises' debt and Treasury securities ballooned. Early Thursday morning, 10-year agency debt was trading at yield spreads as high as 110 basis points over Treasuries, up from about 93 basis points late Wednesday. Spreads on mortgage-backed securities guaranteed by Fannie and Freddie also widened.
"The market is in disarray," said Arthur Q. Frank, director of fixed-income research at Nomura Securities International Inc.
To be sure, agency debt spreads snapped back a bit midmorning Thursday, as "some big money managers came in and said, 'This is just too cheap,' " Mr. Frank said. Freddie went ahead and sold $5 billion of reference notes, and priced them to yield 105 basis points over the 10-year Treasury. By Thursday afternoon, spreads on 10-year agency debt had tightened to 101 basis points over Treasuries.
But Mr. Gensler's testimony still "did some damage to the agency and MBS markets," Mr. Frank said. Indeed, if Freddie had issued its bonds a day earlier, it would have been able to price them 13 basis points tighter.
In his testimony, Mr. Gensler expressed support for some provisions of a bill to reform regulation of the government-sponsored enterprises. The bill was introduced by Rep. Richard H. Baker, R.-La., last month.
Specifically, Mr. Gensler said the Treasury would support a repeal of a conditional line of credit that the GSEs have with the Treasury. He also reiterated several times that the GSEs' securities are not government-guaranteed. In his testimony, Mr. Gensler also said Congress should repeal the exemption of the GSEs' debt from banks' investment limits. The Baker bill calls for a study of deposit insurance funds' exposure to the GSEs but does not go as far as to end the exemption.
While it is well known that Fannie and Freddie's debt carries no explicit U.S. guarantee, it is generally believed that if they encountered financial hardship the government would bail them out.
This implied guarantee enables them to borrow at lower rates than most financial institutions. It also has helped the GSEs market their debt as a surrogate for U.S. bonds at a time when the Treasury is scaling back its own borrowing.
"The market is confused as to what to make of Mr. Gensler's testimony," said Mr. Frank at Nomura. "The Clinton administration needs to clarify its position" on the Baker bill, he said.
Moody's Investors Service and Standard & Poor's released statements Thursday affirming their Aaa ratings for Fannie and Freddie's debt. But the damage was done, and the GSEs were peeved.
One news-wire report quoted Fannie's chief financial officer, Timothy Howard, calling Mr. Gensler's testimony "irresponsible."
A spokeswoman for Freddie Mac echoed those sentiments, saying that Treasury officials "could easily have been predicted" how investors would have reacted to Mr. Gensler's statements "if they had thought about it."
"If they're going to make these kinds of statements that will lead to speculation," the spokeswoman added, "they need to seriously consider what the impact is going to be and who the victims are going to be. In this case it's the housing market and ultimately the American homebuyer."
Much of the selling of Fannie and Freddie's debentures occurred Wednesday night, and some market participants said that Mr. Gensler's remarks were most shocking to overseas investors, some of whom may not fully understand that the GSEs are not explicitly backed by the United States.
"We make that point in all our representations clearly," said Peter Horvath, managing director of debt marketing at Freddie Mac. "However, this situation has demonstrated our need to reinforce that point going forward, as well as the point that our ascendancy to the top of the market in terms of alternatives to [U.S. Treasury bonds] is not dependent solely or even primarily on whether or not there's an explicit guarantee."
After Freddie priced its $5 billion issue, there was some light trading of the bonds at slightly tighter spreads, indicating that, despite the turmoil, the offering was well distributed, Mr. Horvath said.
