Agency spreads widen after congressman casts doubt on support for Fannie Mae, Freddie Mac

By Kenneth Lim

Boston, March 5 - Agency spreads ended just a touch wider than where they began on a roller-coaster Friday after comments by U.S. Rep. Barney Frank cast doubt on the strength of federal backing for government-sponsored enterprises.

Bullet spreads widened by as much as 2 to 2.5 basis points across the yield curve after Frank, who chairs the House Financial Services Committee, told the Washington Post that "people who own Fannie and Freddie debt are not in the same legal position as [those who own] Treasury bonds, and I don't want them to be."

Frank later clarified that he was referring to possible restructuring plans for Fannie Mae and Freddie Mac, which are under federal conservatorship. The Treasury also issued a statement reiterating its stance that both GSEs have the full backing of the government.

Bullet spreads ended about 0.5 bp wider, market sources said.

Michael S. Effron, head of U.S. government agency at Jefferies & Co., said the market was stable in the morning until the congressman's comments.

"Then after the Barney Frank comments we widened out about 1 to 2 bps," he said. "But they came back in after the comments were clarified."

Buyers find bargains

Trading volumes were robust, while callable issuance was also strong, Effron said.

"[Callable] spreads have been tightening all week," he said. "Lower dollar prices today helped bring in buyers."

Another trader said many buyers took advantage of the early widening.

"Really good bottom fishing," the trader said. "Every time it touched support, we saw buyers come in."

Foreign participation could also be picking up after 2009 saw international investors mostly selling their agency holdings.

"It's really funny, especially in the last two or three weeks, if you sit there and you watch the yen and the euro, every time the dollar gains strength against them, we see a lot of buying," the trader said. "When the dollar loses strength against them, we see less buying."

Bark worse than bite

The market appeared to be more annoyed by Frank's comments at the end of Friday than truly concerned that the agencies could lose government support.

"Look, who's using Fannie Mae and Freddie Mac to their benefit right now?" the trader said. "It's the government. They're shoving every bad mortgage off of the banks' balance sheets onto Fannie Mae and Freddie Mac... Their actions speak louder than words."

The trader added that the government is one of the larger holders of agency debt, and doing anything to hurt the credit - such as forcing debt holders to accept a haircut - would hurt taxpayers as well.

Barclays Capital agency analysts Rajiv Setia and James Ma wrote in a note that the congressman's statements "should not be interpreted as a reneging of the existing commitment" to Fannie Mae and Freddie Mac.

The Treasury's current lifeline to the agencies, which is manifested in preferred stock purchase agreements, is also designed "to prevent Congressional politics from interfering with support for existing debt and [mortgage-backed securities] holders," the analysts added.

George Goncalves, head of U.S. interest rates strategy at Nomura Securities, said he doubted that Frank's comments would become policy anytime soon, according to a note. But he highlighted a risk of two GSE yield curves where paper that mature three years and in are significantly richer than longer-dated securities.

In the meantime, Goncalves recommended that investors "gingerly add to three- to five-year paper in GSE space especially in callable space on the back of this widening."

But Effron complained that even if investors do not feel that there is much to be worried about, the market must still react to whatever Frank says.

"Anytime the chairman of the financial services committee says something, you have to pay attention," he said.

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