"The Mother of All Writedowns"?

This tidbit, under the suitably cautious heading, “Rumor Mongering,” appeared on Across the Curve. I’ve found that blog to be sensible, but like journalists, bloggers are only as good as their sources.

From Across the Curve:

I do not believe that I have posted many rumors on this site since i began on January 2. I heard one earlier today and hesitated to post it. But i have since heard the same story from a second source and now feel liberated and will post it. (When I first started in a trading room a the fellow who mentored me and with whom I am still very close remarked that a rumor is a good rumor and OK to spread as long as you didnt make the rumor up yourself.)

The story has it that FNMA and its auditor will part company over write downs and that FNMA will shortly take the mother of all write downs.

That is all.

Whether it proves accurate or not, the rumor probably explains the further widening in agency spreads, which opened up markedly after Fannie and Freddie ceilings were increased in late February. As Bloomberg noted in “Agency Mortgage-Backed Bond Spreads Reach Highest Since 1986” (hat tip The Nattering Naybob):

The extra yield that investors demand to own agency mortgage-backed securities over 10-year U.S. Treasuries reached the highest since 1986, boosting the cost of loans for homebuyers considered the least likely to default.

The difference in yields on the Bloomberg index for Fannie Mae’s current-coupon, 30-year fixed-rate mortgage bonds and 10- year government notes widened about 12 basis points, to 215 basis points, or 79 basis points higher than Jan. 15.

The article argued this rise was due to the alternatives available:

The Fannie Mae current-coupon yield today is 5.84 percent. Investors are comparing that to the yields of about 7 percent or more at which AAA rated, non-agency mortgage securities can be bought and tax-free yields of at least 5 percent to 6 percent on municipal bonds, said Andrew Chow, who oversees about $6 billion in asset-backed bonds at SCM Advisors LLC in San Francisco.

However, this explanation appears insufficient. Agencies generally trade in a fairly reliable relationship to Treasuries. The rise in spreads says other factors are at work. Some of it may simply be the repeated talk in Congress of expanding the GSEs’ role to bail out the housing market. The idea that the government will use the agencies as an insurer of last resort is enough to put fright into any prudent investor.

The chart below only goes to Feb 22, but it isn’t hard mentally to add two weeks to the chart and put the new data point 25 basis points higher than its predecessor.