Fannie and Feddie

Why haven't bond holder gotten a haircut during the financial meltdown?  All of the bailouts have resulted in the Too Big To Fails being saved from bankruptcy..  If you buy a bond from a company that goes effectively bankrupt, you should get a haircut through debt restructuring during the bankruptcy process.  But, the monumental USG bailouts have prevented many companies from failure.  This has created a tremendous future burden on the citizens, which can never be re-paid.

But why were the bondholders spared the pain?  Jim Rickards has recently penned a piece for the FT, which provides some additional insights.

A strange fog has enveloped the bond market. Once, the strength of a bond was based on the reputation of its issuer. But a change began in 2008, as Fannie Mae and Freddie Mac verged on bankruptcy, and legislation was rushed through the US Congress to restructure them. The political importance of these institutions created a new world, one in which a bond’s performance is determined by the reputation of its holders.

Further, Jim argues that the big holders of these bonds would not take lightly to a haircut.

One reason is that Russia and China were among the largest holders of Fannie and Freddie bonds. Recall in 2008 that Russian tanks were rolling into Georgia, while the US was utterly dependent on China to purchase its debt. In Moscow a haircut on Fannie or Freddie debt would have been seen as financial warfare. China’s dismay at losing money might have had even more daunting results, given its power to alter the structure of US interest rates at the touch of a keyboard. So, unusually, the identity of the holders, not the condition of the issuer, determined the bond’s fate.

 Just kicking the can down the road.

Here lies the crux. Policy, whether it be printing money, guarantees or deficit spending, can prop up asset values for a while. This may even be useful in a liquidity crisis. But a solvency crisis is another thing. The longer policy distorts markets by ignoring fundamentals, the longer those reliant on market signals will sit on their hands. The Fed’s recent decision to continue asset purchases shows there is no exit once this path is chosen. As we approach the second anniversary of the Fannie and Freddie bailouts, are we better off? Values cannot recover until they first hit bottom. In short, our economies would be growing more robustly today if we had taken our medicine in 2009.

Here is a link to the full article   http://www.ft.com/cms/s/0/3e726a68-a640-11df-8767-00144feabdc0.html
(you may need to register at the Finacial Times to view the article)

On a  related note...

Debts Rise, and Go Unpaid, as Bust Erodes Home Equity

PHOENIX — During the great housing boom, homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their houses as security. Now the money has been spent and struggling borrowers are unable or unwilling to pay it back.

The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.

follow link here for the rest of the story...
http://www.nytimes.com/2010/08/12/business/12debt.html?_r=1