No Change in Portfolio Strategy Despite Treasury GSE Action

Now that the Treasury has made clear it's plan of action for the Government Sponsored Entities (GSEs), we see little in it's construction that forestalls the ongoing housing recession, prevents rising joblessness, or reverses the recessionary tendencies which have become even more entrenched in recent months.  While the action gives comfort to agency debt-holders that the United States' government will likely make good on all GSE debt obligations, there remains significant questions about the long-term role that the GSEs will play in credit markets once the 2008-2009 period passes. 

In addition, neither the equity injections, credit lines, purchase arrangements, or temporary increases in portfolio limits offer any guarantee that credit terms will be changed to make mortgages more available to potential homebuyers than they currently are.  Therefore, there is no reason to expect a quick and material improvement in the imbalances that continue to confront real estate markets.   In fact, over the short-run, the plan could have the negative effect of making credit even tighter as the government sponsored entities are forced to comply with the new set of standards that will emerge under conservatorship. 

Looking beyond the next year, the call to materially shrink the entities in the post-2010 period would profoundly change the structure of banking and credit markets.  Without an alternative structure in place, the pace of credit creation would likely slow and the cost of credit would likely rise.   Unfortunately, the Treasury's recent actions stop short of offering a vision of what such a system may look like and, instead, leaves that debate to the Congress and the next administration while, at the same time, leaving the GSEs intact as functioning entities. 

We welcome the action as a first step to reform, but are making no change to our recommended tactical asset allocation in response to the Treasury's recently announced GSE action. 

Instead, we remain focused on monitoring changes in the five key indicators which we believe are most important as it relates to portfolio decisions and the outlook for the economy.  By way of reminder, these five indictors have been and remain:

D   Housing
       (continuing oversupply, prices falling)

D Credit
        (shrinking availability and demand for loans)

D Corporate profits
        (peak margins, declining level)

D Private sector employment
        (mounting job losses)

C Pricing of risk in financial markets
        (risk better priced versus a year ago)

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