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RESEARCH NOTE: GSE Takeover--What does it mean for the USD?
Brian Dolan, Chief Currency Strategist
What Happened? On Sunday, September 7, the US Treasury Dept. announced that it was placing the two largest US GSE's (government sponsored enterprises), Fannie Mae and Freddie Mac, into a conservatorship under the control of the Federal Housing Finance Agency (FHFA). The move was prompted by the inability of the GSE's to raise new capital sufficient to offset ongoing declines in US housing assets backed by the GSE's. The purpose of the conservatorship is to buy time while the US housing market adjusts and to permit the GSE's to continue to underwrite and securitize new mortgages.
Under the plans announced over the weekend, the US Treasury will provide additional capital as needed to maintain the GSE's net worth and prevent insolvency. Treasury will provide capital to the GSE's through a combination of a secured lending credit facility (secured by eligible mortgage-backed securities) and a long term Senior Preferred Stock Purchase Agreement. At the moment, there is no estimate of how much capital the GSE's might eventually need, but the Congressional Budget Office (CBO) estimated two months ago that as much as $25 bio may be required. That figure is now considered optimistic; worse case scenarios suggest that $160-270 bio. may ultimately be needed, representing 3-5% of total GSE mortgages being written off. At the end of the day, US taxpayers via the US government will shoulder the burden, but they also stand to benefit from returns paid by the GSE's as operations continue.
What is the impact? The GSE takeover will likely have two main effects in the short run, but this is a long-term package that will likely last until the US housing market recovers sufficiently to be self-supporting, which is likely years away still.
- Stabilization of the US housing market. The Treasury's action has reduced the borrowing costs of mortgage underwriters like the GSE's, bringing down retail mortgage costs for US home buyers. Lower mortgage rates may induce prospective home buyers to step up planned purchases and bring new demand into the slumping housing market sooner rather than later. Lower mortgage rates will also allow homeowners to re-finance at a lower cost and eliminate some potentially burdensome ARM re-sets. This dynamic may ultimately break the vicious cycle of re-sets leading to foreclosures, dumping more unsold inventory on a saturated market, sending home prices lower and creating more upside down mortgages, leading to more defaults, and so on.
- Uncertainty has been reduced. While the long-term outcome of the GSE takeover will play out over the next few years, the short-term impact has been to improve investor sentiment. Now that the GSE drama has played out, investors no longer fear the fallout from the unknown. Also, Treasury's promise to buy new MBS issues guarantees a market for new mortgage issuance, providing other MBS investors with greater confidence. As a result, institutional lenders will now have greater incentives to offer credit, potentially un-sticking the wheels of lending. Credit conditions will likely improve as a result, potentially spurring an earlier-than-expected recovery of the broader US economy in the process.
What does it mean for the USD? The GSE takeover has taken place against the backdrop of a USD recovery of historic speed and proportions, and traders need to draw a distinction between the two events. The USD has surged as economic outlooks outside the US have deteriorated and US data has pointed to stabilization. Improvements in the US trade deficit have also put the USD in a better light. More recently, investor repatriation has seen US investors exit foreign markets and bring funds home, generating demand for USD. Such repatriation flows likely still have more room to run and this keeps the outlook positive for additional USD gains.
To the extent the GSE takeover is a positive for the US housing market and by extension the US economic outlook, it's another broad USD positive. The major potential negative impact of the GSE takeover is how much it increases the US budget deficit. The longer-term implications for the US budget deficit are impossible to quantify at this time, but will be a story to follow over the next several months and years. But with early signs that US housing market declines are showing signs of stabilizing, the outlook would tend to favor less capital being required to fund the GSE's, limiting its impact on the US budget deficit and reducing a potential USD negative.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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