Fannie Mae, Freddie Mac MBS, debt spreads balloon

NEW YORK (Reuters) - Mortgage-backed and corporate "agency" debt obligations issued by Fannie Mae and Freddie Mac dropped relative to U.S. government securities on Thursday as the credit crisis sent money managers racing to raise cash.

But yield spreads by mid-morning narrowed from their widest levels as some order returned to trading in these bonds issued by the two companies, which are the two top funding sources for U.S. residential mortgages.

Yields on Fannie Mae mortgage-backed securities paying 5.5 percent interest jumped by 10 basis points to 2.2 percentage points above benchmark Treasuries, according to Reuters and traders' data. The spread earlier traded as wide as 2.23 points, the most in more than two decades, out from 1.51 points at the start of the year.

The agency debt issued by Fannie Mae to fund its mortgage investments also widened. Yield spreads on the most recently issued five-year benchmark issue of Fannie Mae widened as much as 11.5 basis points to a record 111 basis points, according to the bid quoted by broker GovPX/Garban-ICAP.

The Fannie Mae five-year spread was wider by 4.5 basis points at mid-morning.

Fannie Mae and Freddie Mac, chartered by Congress to raise money for homeownership, provide guarantees on mortgage-backed securities sold to investors. The government-sponsored enterprises (GSEs) also sell debt in the $2.7 trillion agency market to fund a combined $1.4 trillion in investments in mortgages and mortgage securities.

DELEVERAGING

Selling of securities by hedge funds and other money managers that borrowed money to enhance returns in recent years has sent credit markets reeling this week.

Fund managers with ample cash are holding back from purchases of securities for fear prices will fall further, exposing them to scorn of their shareholders, analysts said.

"It's a combination of intense scrutiny from regulators and stockholders as to how these solid firms commit their capital, and that people who like valuations have a hard time keeping up with the news flow and pricing," said Jim Vogel, a strategist at FTN Capital Markets in Memphis, Tennessee.

"It helps explain half of the deleveraging side, which is why people aren't picking up bargains."

Agency MBS, which are seen as having little credit risk relative to mortgage bonds sold by other companies, are being sold partly because the $4.5 trillion market is one of the most liquid, or easily traded, next to Treasuries, analysts said.

Freddie Mac and Fannie Mae have lower borrowing costs than other "AAA" rated companies because they view the companies' congressional charters as implicit government backing. A rumor on Thursday that the U.S. government would provide an explicit guarantee on GSE debt was denied by the Treasury.

Other bearish trends for agency MBS linger, including high volatility and expectations for record supply, analysts said.

(Reporting by Al Yoon, editing by Walker Simon)