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September 08, 2008

Fannie and Freddie Bailout

I think the biggest benefit of the Treasury takeover of Fannie Mae and Freddie Mac is that it will unclog the market for mortgage backed securities. With an explicit US Treasury guarantee, yield spreads on Fannie and Freddie debt should drop sharply. Inventory of MBS should decline. Banks should feel comfortable lending again to quality borrowers with the knowledge that they will once again be able to securitize the loans. The combination of falling yield spreads on mortgage-backed securities and renewed lending by banks should help stabilize the housing market.

If this scenario plays out, the economy is not out of the woods. Economic activity is weak for consumers and businesses across much of the developed economic world. The return of leverage to more reasonable levels remains a huge and lengthy headwind. However, the risk of something worse, like a really deep and long recession or a deflationary depression, appears to have been significantly reduced.

For stock market investors that should be a good thing as it improves the risk-reward tradeoff and reduces the level of uncertainty. How it plays in the very near future is less of an issue for me than how the market performs over the next six to eighteen months. I believe the outlook has improved considerably but I still believe we are in a low return environment until the deleveraging of the global economy is much further along.

Posted by Steve Birenberg at September 8, 2008 08:35 AM in Stock Market