The Trump Trade has emerged as new vernacular across the investment world since Election Day. In just three months, the Trump Trade has led to the Dow Jones Industrial Average breaking 20,000, a S&P 500 Index market capitalization in excess of $20 trillion and—maybe most remarkably—a hawkish Federal Reserve (Fed) Chair, Janet Yellen.
This week’s confirmation of Steve Mnuchin, a former Goldman Sachs executive, as Treasury Secretary will put focus on another sector of the financial markets benefiting from the Trump Trade: Fannie Mae and Freddie Mac preferred securities. This week's chart highlights the sharp rebound in prices for Agency preferreds since the Trump victory.
In 2012, the Obama administration changed the rules of Government Sponsored Enterprise (GSE) conservatorship and swept 100% of the two companies’ profits into government coffers to reduce the budget deficit. Fannie and Freddie preferred investors have argued in court that the U.S. government is illegally seizing these profits.
The Goldman Sachs/Treasury Department/GSE connection will have come full circle if Treasury Secretary Mnuchin is successful in his efforts to transition Fannie Mae and Freddie Mac away from government control. Former Treasury Secretary and Goldman CEO Henry Paulson led the government takeover of Fannie Mae and Freddie Mac in 2008. At that time, conservatorship was intended to be just a “time out” until the government could put the GSEs back on sound financial footing. More than eight years later, Fannie Mae and Freddie Mac remain in government hands.
Key Takeaway:Despite efforts to minimize taxpayer risk to Fannie Mae and Freddie Mac since the financial crisis, these institutions still guarantee 60% of mortgages originated in the U.S. The path to privatization for these institutions is sure to prove challenging given the potential risks to the mortgage market from increased borrowing costs and profits flowing to the U.S. Treasury.
The potential boost to valuations from privatization for existing Fannie Mae and Freddie Mac guaranteed residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS) may be the biggest story for fixed income investors. Scarcity value will become more pronounced in a sector already in tight supply. Nearly $1.75 trillion in agency mortgage-backed securities (MBS) still reside on the Fed’s balance sheet resulting from quantitative easing (QE) purchase activity.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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