Putting D.C. in the Rearview Mirror

 | Oct 21, 2013 | 12:00 PM EDT  | Comments
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Investors must be even more relieved than political analysts that we have moved past the debt threat. Stocks are up more than 2% since before the government shutdown began, and there's no sign of a correction yet. However, we must keep watching student loan policies and mortgage insurers.

But first, here's a short postscript that might serve as prologue. Some investors were confused by misreports based on the text of the bill President Obama signed early Thursday to reopen the government and suspend the debt ceiling. Contrary to one interpretation to the effect that the measure might give Obama the right to raise the limit repeatedly going forward, the current bill simply mirrors the language enacted last January. It gives the president a one-time grant of authority.

The higher borrowing authority will be subject to a disapproval vote in Congress, but the hurdles for passage of such a motion make it hardly worth mentioning.

Once the debt limit reactivates on Feb. 7, Treasury can once again tap "extraordinary measures" to temporarily buy $250 billion or so of room under the newly settled cap. That should buy a couple of months' reprieve from once again hitting "x-date" (the point at which the government can't guarantee its ability to pay its bills), helped along by a $29 billion payment that's likely to come from Freddie Mac, as it follows Fannie Mae's earlier lead in tapping unused deferred tax allowances to write Treasury a check. Nevertheless, the net reprieve will still be shorter, as the moves will be offset by the seasonal outflows (and heavy monthly deficits) associated with annual tax refunds.

Don't Rely on Washington for Entry Points

Thus, we face two inflection points -- and a notional rematch in the fiscal fight -- just three to six months away. But as a former Drexel Burnham guy, I can give you my "highly confident letter": The odds of even a hint of a government shutdown seem quite low, as Republicans, politically, can't afford one, and, unlike last month, they can easily avoid one. How? By passing "clean" funding bills (continuing resolutions), if necessary past the end of the fiscal year or even after the elections.

As for the debt ceiling, it won't be quite as easy or graceful to resolve, but just as the GOP this week allowed Obama to self-activate a borrowing-cap hike without offsetting funding cuts, it seems highly likely to do so again.

Separately, expectations for success of a newly forming House-Senate budget conference committee are now set so wonderfully low that even a modest agreement (say, just paring back the sequester in exchange for a farm bill or other mandatory spending cuts) might be well received on the Street. After all, reducing near-term contractionary spending cuts in exchange for longer-term reforms would reduce fiscal drag.

But how about the notion of a "mini grand bargain" with modest entitlement savings, pared-back sequester cuts and a modest bag of tax changes and reforms? After-burner, baby. Note the postscript accompanying Morgan Stanley's (MS) awesome third-quarter earnings beat, which was fueled by equity trading and wealth management: Mergers and acquisitions won't really return in size until Congress finally gets its act together on a budget deal.

It's certainly too early to bet on anything like that kind of fuel for the afterburner. But it's also too early to rule it out.

Mortgage Insurers' Path Still Straightening

Meanwhile, the positive policy backdrop continues to unfold for the private mortgage insurers. Genworth Financial (GNW), Radian Group (RDN) and MGIC Investment (MTG), have exploded upward this month amid positive word on declining legacy exposure and improving new business. Virtually every major policy decision that could affect them has come down positively this year.

Meanwhile, a 30% down-payment option is likely to disappear from a final Qualified Residential Mortgage rule emerging in the coming months (i.e., the standards that loans must meet in order to be eligible for securitization without a 5% "risk-retention" charge). So the biggest remaining challenge for the mortgage insurers remains the Federal Housing Finance Agency's expected release of new financial standards for insurers that back Fannie-Freddie loans, which represent the industry's bread and butter. If the final standard for risk-to-capital leverage comes in somewhere near 18-1, as many expect, it will seem that another hurdle has been overcome. If a lower ratio is proposed, it will be less salutary but likely still OK as long as a longer adjustment period is allowed.

Ride, Sallie, Ride

Finally, I commend my fellow Real Money contributor Sham Gad for flagging Sallie Mae's (SLM) decision to split the company into two parts as a way to reap both appreciation and dividends. But in my view, he missed a key part of the story.

Specifically, he may be underestimating the potential of the newly formed company holding legacy FFELP (federally insured) loans, which will be blessed with supple runoff income for years to come, even while the repeal of the formerly private-lender-dominated program means that no new such loans will be underwritten.

That hardly means the company or the story will be boring, in my view. Indeed, the fact that it will be run by talented president and CEO Jack Remondi should tell you something. Remondi can be counted on to aggressively seek out and purchase other portfolios from another $150 billion of so in FFELP loans being held by others, who are less committed to the business or to such a dedicated strategy. So as a Washington analyst, I'll refrain from saying a Crameresque "Buy, buy, buy!" But I will say that Sham may be even more on the money than he realizes.

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