Hidden Financial Bombs: Margin Calls Hit Hedge Funds Speculating In Freddie/Fannie Bonds With High Repo Leverage

Markets are more dangerous than ever before because six years of radical financial repression by the central banks have planted booby-traps everywhere. Ground zero consists of massive and reckless speculation in newly invented “structured finance” products which were designed to quench the market’s insatiable thirst for yield in the Fed’s whacky world of ZIRP.

So below is news of margin calls on hedge funds that had piled into a 12 month old product called “risk sharing RMBS bonds”. It seems that Wall Street dealers had provided 80% leverage on these new fangled securities issued by the nation’s accomplished market wreckers—Fannie and Freddie. Various tranches of this new variant of synthetic CDOs—-that is, the Wall Street created toxic waste that blew-up in 2007-2008—- offered yields of 200-700 basis points over LIBOR, but so great was the demand for an alternative to the Bernanke-Yellen ukase of zero return that prices of the first Freddie Mac issue were driven up by 30% over the past year.

Now imagine that. Speculators purchased newly invented and unseasoned securities from proven financial malefactors on 80% leverage and then saw their price rise by 30% in 12 months, meaning that the return on their own invested equity was a cool 150%. Stated differently, the scramble for yield got so frenzied that securities originally issued at a yield premium of 7.15% over LIBOR last summer had soared to the point that they yielded only 2.5% over LIBOR before the market broke a few weeks ago. A recent WSJ article captured the thought that irrational exuberance had indeed erupted in this newly invented “asset class”:

But, the rally was overextended by investors’ search for yield as Federal Reserve stimulus cut returns on safer assets, some investors said. Prices on Freddie Mac’s first issue of July 2013 had soared more than 30% through May, reducing yield premiums over the one-month London interbank offered rate to 2.5 percentage points from 7.15 percentage points.

“Investors got too complacent,” Mr. Hentemann said. “They kept buying high-yielding assets to a point where prices and yields didn’t compensate you for the risk.”

Given the financial mayhem that the GSE had already caused, it might be asked why the government’s bankrupt housing guarantee agencies were back in the fray peddling a new form of securitized snake oil in the Wall Street casino. The answer is that some well-intended bureaucrats at the GSE regulatory agency told them to off-load onto private capital markets some of the GSEs’ accumulated risk to the taxpayers.