As muni bond investors know, bonds that fulfill important public purposes receive special consideration when under stress. So it should be no surprise to tax-free bond holders that the treasury department this week pledged to support Fannie Mae and Freddie Mac.
Treasury Secretary Henry M. Paulson, Jr.’s pronouncement and three-point plan are intended to stabilize the financial markets and remove any doubt about the federal government’s commitment to the two Government Sponsored Enterprises (GSE).
GSEs are chartered by Congress, but they are also private companies whose stocks and bonds trade publicly. Both companies are rated “AAA” based on implicit guarantees by the U.S. Treasury.
Fannie and Freddie are the main providers of credit supporting the private mortgage markets. Through their willingness to purchase thousands of mortgages from banks and other lenders, these entities provide needed liquidity to the mortgage markets and act as the federal government’s main instrument of support for the nation’s housing policy.
Recent turmoil in the housing market has caused public confidence in many Wall Street institutions to drop precipitously, Fannie and Freddie included. (Both GSEs had seen their stock values cut in half during the week preceding the Treasury announcement.)
With this recent action, treasury department officials took the unusual step of announcing its willingness to provide an unspecified increase in the line of credit both GSEs receive from the Treasury, thereby providing additional liquidity when needed. The plan also includes giving the department temporary authority to purchase increased equity in Freddie and Fannie, if necessary. Finally, officials will ask Congress to increase its oversight role over both companies.
‘Essential’ projects
Similar to Fannie and Freddie’s bonds, municipal bonds serve as funding instruments of state and local government policy.
The “essentiality” of bond-funded projects underlies any fundamental analysis of a municipal bond and its credit quality. The fact that virtually all municipal bonds are issued for public purposes such as schools, roads, and water and sewer systems, means that governments at all levels will spare no effort to meet their debt obligations and retain access to the capital markets.
The Freddie and Fannie story reiterates what muni investors have known for years. The more essential the bond’s purpose, the more extensive the effort to see that it pays.