Government bailouts for private banks are having a strange impact on bond markets, says Andrew Gordon. Fed guarantees have investors swapping traditionally safe government sponsored enterprise bonds for corporate bank bonds. This means higher yields on GSEs like Fannie and Freddie. And that’s great news for companies that invest in GSE bonds like MFA (NYSE:MFA) and Anworth (NYSE:ANH).

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Equities aren’t the only markets acting strangely these days. The bond markets are acting even stranger.

For both bond and equity markets the cause of this strange behavior is the same: Piecemeal government actions in the U.S., Europe and Asia culminating in massive intervention.

The U.S. government is trying to nurse the economy back to health. And like a doctor who has a pill for anything that ails you, the U.S. government is trying to find a cure for practically every ailment afflicting the economy.

Sometimes when you’re on a lot of medication, you don’t know if it’s the symptoms or side-effects which are causing the most pain.

One thing is sure, the government has flung open the doors of its heavily stocked pharmacy and has emptied its shelves on the poor economy.

And when the meds don’t work, they simply put the targeted patients on life support – as they did with Freddie, Fannie and AIG.

Well … except for that one patient that got away … Lehman Brothers. At the time the government more or less said, “We can’t save them all.”

Now the government is more or less saying, “let’s save them all.”

No wonder the markets are confused. These government prescriptions are having all kinds of confusing side-effects…

Like when the government decided to lend to banks in return for asset-backed commercial paper. Investors were soon favoring the higher-yielding asset-backed debt of these banks over corporate and European bank debt which did not enjoy such government backing.

It’s no coincidence that the European bank crisis began to accelerate about this time.

And when the FDIC guaranteed bank deposits of up to $250,000, money-market funds cut back their investments in short-term commercial paper and held on to more money for themselves. Why? They feared that savers would begin leaving money-market accounts for safer (but lower-yielding) government-backed bank accounts

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The government may have eased the concerns of bank customers, but for a time it helped make credit markets even tighter.

Every time the government gave the economy a remedy that worked in theory, more unforeseen symptoms appeared.

Now we have an economy reeling from both the original causes of the crisis – reckless lending by banks and interest rates that were way too low – and some very clumsy moves by the government.

You can tell from the markets’ crazy swings that it doesn’t know what to make of all this.

And, sure you can argue that it’s created some bargains in the stock market – a lot of companies are going at half price.

But with money still tight and revenues falling off, the key question for these companies isn’t how cheap they are, but how much cash they have. In other words, can they survive without having to sell all the furniture?

The bond market is also obviously affected by concerns over survival. The price of corporate junk bonds has fallen to record lows.

On the other hand, bank bonds are selling like hotcakes. Can you guess why? Yep, it’s the government stepping into the breach once again. To help banks raise much-needed capital, it has guaranteed bank bonds.

You hear of lots of money pouring into the safety of Treasuries. That’s fine. That’s bond investors reacting to risk. That’s NORMAL.

But lots of money is also fleeing Freddie and Fannie bonds into government-guaranteed bank bonds. For decades Freddie and Fannie bonds were the safest bond investments next to Treasuries. And, then, on September 7th, the government announced its promise to safeguard Freddie and Fannie’s $3 trillion bond market.

So what’s happening now is very ABNORMAL.

Freddie’s and Fannie’s bonds get about a percentage point more in yield than Treasures. Investors liked getting the extra yield while accepting very little risk.

But why settle for those yields when you can get even better ones from bank bonds. Not only that, you can also get a government guarantee that is just as strong if not stronger than the ones covering Freddie and Fannie.

So investors are selling off Freddies and Fannies and going to greener pastures sprinkled with government manure (all you have to do is hold your nose). That naturally has driven down the price of Freddie and Fannie bonds while raising their yields.

And that’s great news for a group of companies which invest almost exclusively in the bonds of Freddie and Fannie.

They’re very conservative in using leverage but they do use it. Then they simply apply the time-honored formula of borrowing low and investing high. Freddie and Fannie bonds give them more than enough spread to enable these companies to give their investors up to 8-10 times more money than your current savings account is probably earning. Plus, there are no minimums and no extra charges or fees to pay.

A couple of the companies that are investing in the debt of Freddie and Fannie and other GSEs are MFA (NYSE:MFA), and Anworth (NYSE:ANH). The long hand of Uncle Sam is making them and companies like them big winners.

Source: Boring Bonds Offering Great Deals