In the summer of 1868, Mr. George Hull of Binghamton, New York, decided to pull off a hoax. No, not about Bigfoot – but close. He had a gypsum block carved into the shape of a giant dead man and buried at a farm near Cardiff, New York. And then later, he had it dug up.
Keep in mind this was a gypsum statue. Nevertheless, thousands of people flocked to pay and see "Mr. Hull’s giant."
Soon thereafter, a syndicate paid $30,000 (in 1868 dollars) for a majority interest in the giant. A member of the syndicate, a banker named David Hannum, raised the admission price. Not long after that, a renowned sideshow promoter and politician P.T. Barnum offered $50,000 dollars for the giant.
It was later said by Mr. Hannum (talking about P.T. Barnum, but it's a quote often incorrectly attributed to P.T. Barnum himself) that, “There's a sucker born every minute."
Here we are, 140 years later. We have just uncovered a giant leveraged debt mess, but there are still suckers out there willing to buy this paper. As we move into the later innings of this credit crunch, one of its untold stories is the recapitalization that has taken place in the financial industry – despite the writedowns that have persisted at record levels for two full quarters.
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Without the sale of assets, equity dilution, vulture capital, hostile takeovers and bailouts this leverage bubble implosion would have been at least a recessionary event – or a far worse one. Some of these deals have been astute transactions, others… have not. Either way, though, the pool of available suckers appears to be shrinking.
Market values of both Fannie Mae and Freddie Mac have declined dramatically – to $6 billion and $2 billion, respectively. Both are paying penalty spreads over Treasuries to sell debt while demand is rapidly in decline. The question is, how high will yields have to go to generate demand?
Each of these two GSEs have more than $100 billion in debt maturing before October, and foreign buyers – typically a reliable well of demand – have been scarce of late. That leaves us with the buyer of last resort: the U.S. Treasury, which may have to buy more than $30 billion of GSE preferred shares just to get us through Q4.
The forthcoming supply of Treasury bonds could weigh more than Mr. Hull’s giant – and be worth less.
Bill Fox is EWI's Senior Bonds Analyst. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders spread around the globe.