- The Washington Times - Tuesday, July 29, 2008

The fastest inflation in 17 years and a fourth straight quarter of declining corporate profits are turning debt sold by Fannie Mae and Freddie Mac into the favorites of the world’s biggest bond investors.

Pacific Investment Management Co., T. Rowe Price Group Inc. and other investment firms say the government’s decision to stand behind the beleaguered housing-finance companies make the bonds a buy.

The Senate approved legislation Saturday allowing the U.S. to inject capital into Fannie and Freddie. President Bush plans to sign it into law.

“We like it,” said Bill Gross, who oversees the $128 billion Total Return Fund, the largest bond fund in the world, for Pimco of Newport Beach, Calif. “This legislation has indicated to investors that Fannie and Freddie are not implicitly guaranteed, not explicitly guaranteed, but we’re close to that point.”

Corporate bonds, mortgage securities and Treasuries have returned 0.5 percent on average in 2008, Merrill Lynch & Co. index data shows. This year is the worst for fixed-income investors since 1999, when they lost 1 percent. The securities gained 7.17 percent on average in 2007, including reinvested interest.

The bond market isn’t providing investors with enough income to cover the rate of inflation, which rose 5 percent in the year ended June 30, Labor Department data show.

Treasuries returned 1.8 percent since December, after posting losses of 2.1 percent the three months that ended June 30, the worst quarterly performance in four years. Corporate debt is down 0.2 percent, losing 0.7 percent last quarter, Merrill data show.

Debt sold by Fannie Mae and Freddie Mac has returned 1.63 percent this year even after losing 1.72 percent last quarter, according to Merrill Lynch index data. Bonds backed by the mortgages they own returned 0.73 percent this year after a loss of 0.66 percent in the three months that ended June 30, a separate index shows.

The performance of U.S. assets “is a reflection of the environment we’re in today, which is a sluggish economy with some inflationary concerns,” said Colin Lundgren, who is buying agency-backed mortgages as head of institutional fixed income for RiverSource in Minneapolis, which oversees $40 billion.

Washington-based Fannie and Freddie of McLean buy mortgages from lenders and either hold them or package them as securities for sale to investors. The government-chartered companies account for almost half of the $12 trillion U.S. mortgage market.

Fixed-rate mortgage bonds guaranteed by Fannie or Freddie are attracting buyers because the debt yields about 1.5 percentage points more than Treasuries with similar maturities, according to Lehman Brothers Holdings Inc. data. The gap between the yields is approaching the widest point in two decades that was set in March, the data shows.

Investors lost confidence in the debt this year on concern Fannie and Freddie wouldn’t have enough capital to cover losses. Foreclosure filings more than doubled in the second quarter from a year earlier as falling home prices left borrowers owing more on mortgages than their properties were worth.

The companies reported combined losses of more than $11 billion over the past three quarters and the total may climb to $48 billion by the end of next year, according to a July 18 report by JPMorgan Chase & Co. analyst Matthew Jozoff in New York.

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