Fannie and Freddie

Treasury Secretary Hank Paulson announced on Sunday that it would guarantee Fannie Mae and Freddie Mac, the two government-sponsored public home mortgage purchasers. (Read Paul Krugman on it here.)

This is a smart move on Paulson's part for the following reason: the mortgages, for the most part, are money good. Fannie and Freddie do not have any subprime mortgages, by definition. Despite the fact that the ABX AAA (a rough measure of the probability of default of mortgage backed securities of that rating) is trading a 50, it's extremely unlikely that 50% of those mortgages will default. Therefore, while Fannie and Freddie may need some injection of government capital (raising valid questions about the bizarre mix of capitalism and socialism that govern the two organizations), they are not likely to lead massive government bailouts.

The timing of this announcement is interesting as well. Conventional wisdom is that the rate cuts of the past year will take about 12-18 months to take effect. This means that the equity markets will likely turn the corner within the next year. Paulson's actions are therefore a stop gap measure to boost confidence at a time when the equity markets are bearish, until they begin to recover.