Government intervention in the market does not stop the market from functioning and every action they take has unintended consequences (via the WSJ):
Government efforts to heal the credit markets are having unintended consequences that are roiling different sectors of the market and adding to anxiety among investors, who already are worried about the impact of a possible recession on U.S. companies.
Barely two days after the Treasury announced plans to buy stakes in U.S. banks and the Federal Deposit Insurance Corp. said it would provide guarantees on bank debt for three years, investors are making unexpected shifts.
Wednesday, bonds issued by mortgage providers Fannie Mae and Freddie Mac sold off sharply, even though these companies have government backing behind their debt. Traders said hedge funds were forced to sell as they deleverage, and investors were selling some Fannie and Freddie bonds — known as agency debt — and shifting money into bonds issued by large U.S. banks. These bank bonds boast higher yields and also would benefit from implied government guarantees, making them appear relatively safe in the eyes of risk-averse investors, for now.
Market participants moved money to the new government backed debt with a higher yield. Nothing surpising about that.
The agency debt’s selloff is the latest unexpected market response to Federal Reserve and Treasury attempts over the past few weeks to plug the financial system’s holes. The bailout plans may force the U.S. to issue new government debt that could drive up interest rates on mortgages, undermining efforts to rescue the housing market, the very problem that started it all.
It shouldn’t be unexpected. Government intervention cannot prevent the adjustment process of the market. The market always wins. The best policy would be for the government to get out of the way and let the market find it’s natural level. Further interventions will just cause other unintended consequences.