Fellow US banks were quick to follow Goldman in what could be a $300bn or more market, bankers said. JP Morgan and Morgan Stanley were among those lining up with similar debt sales. A flourishing market for such debt already exists in Europe after deals from UK banks such as Lloyds TSB, Royal Bank of Scotland and Barclays.
Goldman sold $5bn, significantly more than originally expected, with a yield of 3.367 per cent, or a spread of 200 basis points over comparable Treasuries, for debt that has the backing of the US government and matures in June 2012. The spread on the bonds tightened to 185bps in trading.
The FDIC-backed bonds are being issued under the temporary liquidity guarantee programme, one of many federal schemes meant to revive the financial system. At issue now is whether the cash the government is pumping into the banking system will filter through to the broader economy.
"Once banks raise that money, what do they do with it? Will it spur new lending?" asked Jay Mueller, senior portfolio manager at Wells Capital Management.
The FDIC backing allows banks access to cheap funding as they face about $386bn in debt maturing through the end of 2010, according to Standard & Poor's. Sky-high yields and widespread nervousness about the financial health of even the largest of US banks have shut down the credit markets.
"Without the government guarantee, $5bn of three year money would come at a massively higher yield," said Rob Kay, head of the investment-grade syndicate desk at Credit Suisse.
Spreads on corporate debt, and bank debt in particular, have soared to record levels. Existing Goldman debt was quoted yesterday with a spread of 750bps over Treasuries, or a yield of 9 per cent.
Banks are selling the new debt to investors who typically buy obligations of the government-sponsored enterprises Fannie Mae and Freddie Mac.
That has raised questions about the relative appetite for GSE debt, which carries a slightly weaker government guarantee.
Also yesterday, the Federal Reserve said it would buy up to $100bn of debt from Fannie and Freddie and the Federal Home Loan Banks. Those risk premiums tightened 20 to 40 bps. A three-year Fannie Mae bond now trades at a spread of 160bps. It will also buy up to $500bn of agency mortgage bonds.
Jason Brady, portfolio manager at Thornburg Investment Management, said: "What the government didn't want was Goldman and the banks to benefit from cheap funding at the expense of the mortgage borrowers."
Comment on FT's Alphaville blog:
Goldman Sachs officially became the first US bank to issue FDIC guaranteed yesterday. But as some commentators are pointing out, where does this leave appetite for GSE paper? Furthermore, isn’t encouraging a potential slowdown in GSE paper sales actually a much bigger problem for the markets considering the paper lies largely at the core of the current crisis?
All of this, of course, was supposed to have been sorted out in September when the government put the GSEs into conservatorship. The move was taken by many as finally resolving the issue of whether GSE paper was indeed guaranteed by the government or not. Speaking on the matter on September 7th Paulson said:
Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.
Not exactly an ‘explicit’ guarantee, but certainly an inferred guarantee by the conservatorship status of the GSEs.
On November 20th Paulson shed some more light by saying this:
On September 7th the FHFA placed Fannie Mae and Freddie Mac into conservatorship, and Treasury put in place a preferred stock purchase agreement that in essence guarantees all GSE obligations for their duration. We replaced both companies’ CEOs and took warrants for up to 79.9 percent of each company. By stabilizing the GSEs, we’ve enabled them to play their vital role in making mortgage finance available and affordable as we work through the housing correction.
‘In essence’, being the key phrase.
So is agency paper guaranteed explicitly or not? It certainly has the markets confused.
Goldman paper due 2012 (3.5 years) issued under FDIC’s Temporary Liquidity Guarantee program priced in at 200 basis points over Treasuries on Tuesday, while a three-year Fannie Mae bond now trades at a spread of 160 basis points. (Spreads on GSE paper, also, of course, can only go so high before the GSEs decline to issue at all; the margin in their business model being so tight)
What is specifically telling though is the size of the issue: Goldman selling $5bn of notes, much more than originally anticipated. This can be taken to indicate the degree of investor demand for the Goldman securities.
Appetite for GSE paper meanwhile has been increasingly flagging, even if lower yields relative to Goldman’s FDIC-guaranteed issue might at face value appear to indicate the contrary. Also telling, the first sales of Fannie and Freddie long-term debt in November saw spreads widen significantly.
In a Nov. 10 filing Fannie admited it had “limited ability to issue debt securities with maturities greater than one year,'’ and that it was relying on short-term funding, which exposed it more to the risks in interest rate changes.
Bloomberg quotes Federal Home Loan Bank of Atlanta CEO Richard Dorfman in an interview in November referring to the doubts the market still had over the GSE paper:
Many central-bank traders have told our investment banks that they themselves are very comfortable with this paper, but from a policy level, it raises doubts
Unsurprisingly the market is questioning the guarantee now more than ever. Is it explicit or implicit? In October, James Lockhart, director of the Federal Housing Finance Agency said:
The conservatorship and the access to credit from the U.S. Treasury provide an effective guarantee to existing and future debt holders of Fannie Mae and Freddie Mac.
Yet even the FT writes today that GSE debt appears to have a weaker guarantee.
Those thoughts are echoed by Vince Farrell, CIO at Soleil Securities. Regarding the Goldman sale, he writes:
Also, the explicit guarantee of new bank debt left investors wondering why they should buy agency paper that had only an “implied” guarantee.
And just to fully express the confusion, Marketwatch says this:
The FDIC guarantee is deemed by analysts and investors as equal to the full faith and credit of the United States and even better than the implicit guarantee of debt issued by the big mortgage-finance agencies, Fannie Mae and Freddie Mac.
If all this is the case, could it be that GSE paper was never explicitly guaranteed by the government despite elaborate efforts to suggest it was? And if so why? It was, after all, the issue that really kicked off the destabilisation in the markets in September. Foreign holders of GSE paper had reportedly demanded the US government finally make its position clear on the guarantee.
So could it be that Paulson has actually got away with a somewhat sneaky maneuver - never actually guaranteeing Fannie or Freddie debt, simply inferring it was by providing $100bn to each to stop the agencies’ net worth falling below zero.
Either way, people are clearly confused. Announcing the purchase of $100bn of GSE paper and another $500bn MBS (potentially also from the GSEs) by the end of the year hardly solves the problem. Those sums are about 5 per cent of the total outstanding debt sitting on the books of all three GSEs. What’s needed is for the Treasury to finally make a formal statement on its guarantee position.