Thursday, October 16, 2008

More Unintended Consequences

Earlier this week, I wrote about the rising mortgage rates coming after the Fed lowered its Fund rate by 50 basis points.  At that point, I suggested the reason for the increase coming on the decrease may have resulted from investor fears of inflation.  While that may be a part of the case, something else more immediately ominous may be in play.

Bloomberg has an article on Monday’s bond sales reporting a disturbing trend.  Yields on Freddie and Fannie corporate debt rose to record heights against treasuries.  The reason comes from another government attempt to stabilize the mortgage market.

 In a Monday announcement, the Federal Deposit Insurance Corporation (or the FDIC as many of you may have seen engraved on placards hung on your bank walls) put the full faith and guarantee of Uncle Sam on newly issued, unsecured debt from some banks. 

Their good intention was to raise confidence in U.S. banks, calm investor nerves and thus get the lifeblood of credit flowing again.

However, these bank notes are carrying greater yields than those for the GSE’s.  So why should an investor buy troubled Fannie and Freddies’ notes when they’ve got a choice for safe, higher paying bonds backed the FDIC? 

Of course, there’s good will and a general humanitarian spirit.  But in lieu of that, there’s going to be less demand for Fannie and Freddie’s bonds.  And that means to compete the GSE’s will have to offer a higher premium.

CNN Money has a concurring report under the headline, “Mortgage rates spike - biggest jump since '87 

The whole credit crisis started from the collapsing housing market.  Now some of the attempted treatment may have the side effect of worsening the onset illness.

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