Freddie Mac's $6 billion preferred offering is supposedly going to yield between 8.5 and 9%. It has a five year call feature, after which it will become floating. So you might say the preferred will have a +500ish spread to the five-year, which is certainly expensive debt.
Now comes the moment of truth. See, Freddie Mac was always going to be able to get fresh capital. I'm highly skeptical of "too big to fail," but in Freddie's case, they are. So no one seriously doubted that Freddie could sell new preferred shares. The question was how difficult and expensive would it be? How would the market receive it? Would this market agree to fund what is in essence, one gigantic portfolio of subordinate mortgage credit.
So where does that leave other financial institutions looking for new capital? Consider that many domestic and foreign banks/insurance/other financials are suffering from mortgage-related losses of one type or another. Some, like Countrywide, Rescap, etc. have been singled out as in particular trouble. But many others really just need a capital infusion to absorb the losses and move on. We know Citi's already raised some cash (which really wasn't at 11%, but expensive none the less). I'd suspect many others to come forward looking for new capital: Washington Mutual, National City, AMBAC, MBIA just to name a few.
The key will be how the new Freddie preferred trades post issuance. It's a $6 billion deal, so its bound to attract a trading volume not normally associated with the preferred market. Will traders push it lower? If so, what kind of level would someone like AMBAC or MBIA have to pay to raise new capital? Maybe the price would be so high as to make it an untenable trade.
Conversely, will the high yield attract real money buyers? That would push the preferred price higher. And that would open the door for other banks to come to market at reasonable levels. Liquidity would improve. Spreads would normalize.
Bear markets don't end when the bad news ends. Bear markets end when prices reflect all the bad news. Usually when market prices reflect more than all the bad news. When confidence in the future improves. When the sellers of risk are exhausted and buyers of risk emerge. Freddie Mac's offering is a test of where we are in this bear market. If Freddie's preferred is beat up post sale, we've got a long road ahead of us. If it does well, then maybe this credit cycle will be short.
So we've locked our S-foils in attack position, and we're headed down the trench. Is this Death Star I or II?