GSE Debt is now EXPLICITLY Guaranteed

Last night I made a huge sacrifice for everyone…I sat through a dinner/speech on monetary policy given by St. Louis Fed President James Bullard. Mr. Bullard is a great guy with a pretty good sense of humor for an economist. Most of the night was pretty standard fare, a review of the history that got us here, a description of the Feds mandate, yada-yada-yada. The real gem of the night came in his prepared remarks when he said…and I quote:

“The GSE’s were previously implicitly backed by the US Government, and the recent action (conservatorship) makes that backing completely explicit.”

Take a moment and read that again…I’ll wait right here…

The fact that GSE debt is now explicitly guaranteed means that those instruments should be trading much closer, if not on top of, comparable Full Faith and Credit paper. The only difference between Treasury debt and GSE debt at this time is that eventually the GSE debt will come out of conservatorship in one form or another. This will only happen when the GSE’s are in sound financial condition. In the interim, based on President Bullards comments the GSE’s provide the same level of safety as US Treasury bonds.

We believe spreads on GSE debt should eventually begin to reflect this Full Faith and Credit Guarantee. The Treasury and the Fed understand this very well. They are trying to restore confidence in the financial markets…and what better way to do that than to remove any question about the backing of the GSE’s?

As this market calms down, and as we begin to see the inter-bank lending market unfreeze, and as we see the trading activities of institutional desks return to normal after the threat of pulled lines of credit begins to wane, we will see GSE yields begin to converge on Treasury yields. I don’t anticipate they will ever trade exactly on top of them due to the eventual change in the GSE’s status some years down the road, but in the mean time they are full faith and credit and spreads should tighten.

What does this mean for investors? It means you buy GSE debt with the same level of confidence that you would buy a US Treasury with…except you’ll feel better about it because you get a much better yield than you would on a Treasury bond. If you have any board members that have been losing sleep about the GSE’s you need to send them this e-mail and take away their Nyquil. They have zero cause for concern over any GSE debt.

I’ve attached the full text of Fed President Bullards speech. If you have any questions on this material please let me know.