So Bill Gross’s Pimco has got what he wanted – a bailout of Fannie/Freddie, all in the name of saving the world from financial meltdown.
Pimco is of course, loaded to the gills with GSE mortgage-backed securities and has been screaming for Treasury intervention, with heightening intensity, for months. So it’s not a surprise to see Gross making comments like these, to the WSJ today:
The Treasury doesn’t want to guarantee a trillion in assets … but it’s a big step. I think not only the Pimcos of the world, but also the sovereign wealth funds and central banks will gain confidence that there is absolutely no possibility of default.
Gross took a punt on MBS back in May — boosting it to about 61 per cent of his total holdings, all based on the US government’s implicit guarantee of the mortgage giants. Had the bailout failed to materialise, Pimco would be in trouble. Big trouble. Like Bill Miller of Legg Mason trouble. All this because of the supremacy of debtholders over shareholders as Deutsche Bank credit strategist J Reid notes:
It is also another example of how sacred debt holders of financials generally are relative to their equity holders. Rightly or wrongly, bondholders of financials will likely be spared the full free market consequences of this credit crisis. Senior and subordinated Fannie and Freddie bondholders now look to be fully backed by the Government. With regards to their shareholders, they should now be effectively wiped out save any option value in the event of a stunning recovery in the institutions. The preferred shareholders will also be hurt and subordinate to the bail-out but with Paulson suggesting that the regulators “are prepared to work” with the “limited number” of smaller banks that hold the stock to “develop capital restoration plans”. S&P have cut the preferred ratings on both GSEs to C from BBB- after the announcement. However the subordinated bonds rated BBB+, are now being considered for an upgrade after previously been on review to be cut.
Miller took a similar gamble to Gross this summer, boosting his stake in Freddie to 12 per cent, making Legg Mason the mortgage lender’s biggest shareholder. Why the wager? There’s a hint in an old interview with Asia Investor magazine, where Miller is quoted as saying:
In dumping shares of Freddie Mac over credit concerns, investors missed the point… Freddie Mac and Fannie Mae are a solution to, rather than cause of the credit crisis… Freddie is trading in the low $20s and we believe should earn half that price or $10 within five years.
There’s little from Miller about a possible bailout of Freddie, which suggests equity investors may have been too focused on the technical solvency/surviveability of the mortgage giants, glossing over the risks the weakened organisations were perceived to be posing to the housing market and the potential gains to be had by strengthening them. Fannie/Freddie may indeed have been part of the solution, just not in the form Miller envisaged.