A GSE Perspective

A GSE Perspective:
On more than a few occasions over the years I’ve been accused of having an obsession with the GSEs. For some time I’ve viewed these institutions as the key linchpins for a historic Credit Bubble along the lines of John Law’s eighteenth-century Mississippi Bubble. The GSEs, with their implied government backing, forged a fundamental – and momentous - change in the nature of contemporary “money” and Credit. Their financial and economic impact has expanded exponentially since their initial foray into system liquidity backstop operations back with their 1994 bond market/hedge fund “bailout.” I am left to scoff at the CBO’s $25bn estimate for the likely eventual cost to the American taxpayer.

With the GSEs’ quasi-governmental status, the markets have merrily assumed GSE obligations would be, if necessary, backed by the full faith and Credit of the U.S. government. It remains an irrepressible Bubble. Washington (democratic and republican administrations, congress, and the Federal Reserve) and Wall Street were happy to live/thrive with the grey area of the markets’ acceptance of implied government backing. Importantly, this market perception granted the GSEs the extraordinary capacity to create at will contemporary “money” (financial instruments perceived as being safe and liquid) and (extraordinarily appealing) Credit. This “moneyness” of GSE obligations played an instrumental role in profound changes experienced throughout the financial and economic world over the past 15 years. Never in history has an inflationary mechanism enjoyed such capacity to issue endless quantities of “money-like” instruments with nary a public protest or market backlash (at least as long as asset prices were inflating). And even recently, despite heightened market concerns, Freddie was not impeded from expanding its retained portfolio $21bn during June, or 33% annualized.