‘Unprecedented’
Using the word ‘unprecedented’ too often risks diluting its significance. But with the US government’s rescue of government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, we are once again in unprecedented territory, following on from the Federal Reserve’s aggressive intra-meeting rate cuts, the opening of new Fed lending facilities, and the last-ditch rescue of Bear Stearns (which was, after all, only four months ago). The scheme by the US Treasury and Fed is likely to buoy Fannie and Freddie’s debt spreads and share prices, now that the implicit government guarantee of the GSEs’ debt has become all but explicit. The five-year credit default swap for both, which had spiked well above levels you would expect for an entity backed by Washington since the beginning of the credit crunch in July 2007, should come down from Friday’s worrying levels (see chart below). And we would also anticipate fears easing at least for the moment about some of the financial stocks we have long been wary about, including Lehman Brothers.
Of course, the Bear Stearns rescue deal in March kicked off a bear market rally. But eventually the exuberance faded, and stocks have again hit new lows. What we know so far about the GSE bailout plan does not change our fundamental view that the capital markets and financial sector remain in trouble. In fact, one unintended consequence of the GSE rescue package is that it may eventually be taken as a signal that there remains little capacity for Washington to undertake further bailout operations.