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Put Frannie on government books, Congressional Budget Office says

Section: Daily Dispatches

Cost of U.S. Loans Bailout Emerging

By Krishna Guha, Michael Mackenzie, and Nicole Bullock
Financial Times, London
Tuesday, September 9, 2008

The United States on Tuesday began to face the financial consequences of the bailout of Fannie Mae and Freddie Mac after Congress' budget watchdog said the housing giants' operations should sit on the government's books and the cost of insuring against a US default crept higher.

With the stock market tumbling, the non-partisan Congressional Budget Office said the government takeover of Fannie and Freddie meant the companies should no longer be regarded as outside the public sector.

Peter Orszag, CBO director, said: "It is the CBO view that Fannie Mae and Freddie Mac should be directly incorporated into the federal budget."

The Bush administration appeared to be caught by surprise. A spokeswoman for the Office of Management and Budget told the Financial Times: "We are working through this issue with Treasury and other stakeholders."

The White House could take a different view on Fannie and Freddie and exclude them from its budgets. But this would be difficult because the CBO is regarded as the leading independent authority on US finances and its assessments guide spending decisions by Congress.

The two mortgage companies have between them $5,400 billion in liabilities, equal to the entire publicly traded debt of the US, alongside mortgage-related assets of about equal value. These will now all be accounted for by the CBO, although public accounting rules mean that its tally of US government debt may not necessarily increase by $5,400 billion.

The CBO bombshell came as it raised its baseline estimate for the US budget deficit to $407 billion this year and a record $438 billion next year owing to falling revenues and higher spending, some of it related to the fiscal stimulus.

The price of credit default swaps on five-year US government debt hit a record 18 basis points in early trading, according to CMA Datavision. This means that it costs $18,000 a year to buy insurance on $10 million of US government debt.

Tim Backshall, chief strategist at Credit Derivatives Research, said the price implied that the US was more likely to default on its obligations than Japan, Germany, France, Quebec, the Netherlands, and several Scandinavian countries. Traders said the CDS market for US debt was illiquid and it was hard to see evidence of increased concern over US creditworthiness in broader market prices.

The price of US government bonds rose and yields fell across the board, as concern over the economic outlook overwhelmed any rise in perceived credit risk. Jay Mueller, senior portfolio manager at Wells Capital Management, said: "We are seeing flight-to-quality buying of Treasuries."

Both Standard & Poor's and Moody's Investors Service said the government takeover of Fannie Mae and Freddie Mac did not affect the US's triple-A sovereign credit ratings. "It does represent some deterioration in the US balance sheet, but it's well within what we would call the triple-A space," said Steven Hess, senior credit officer at Moody's.

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