A strange fog has enveloped the bond market. Once, the strength of a bond was based on the reputation of its issuer. But a change began in 2008, as Fannie Mae and Freddie Mac verged on bankruptcy, and legislation was rushed through the U.S. Congress to restructure them.

The political importance of these institutions created a new world, one in which a bond’s performance is determined by the reputation of its holders.
Next week the U.S. Treasury hosts a major conference to discuss Fannie and Freddie’s future. But to understand how they changed the rules, we must return to the circumstances of their restructure.
Such things are normally straightforward. Equity is wiped out, assets are revalued and the gap in the balance sheet is uncovered. Bondholders take a “haircut” – meaning a lower than expected return – or a principal reduction.
Some principal converts to equity, management is replaced; voilà, life goes on. But for Fannie and Freddie none of that happened. Both institutions were bankrupt. Today their stock trades at a steep discount, but it still trades.
Those who held their debt took no haircut at all. Their assets were never fairly revalued and the balance sheet was replenished with taxpayer funds. Why the different treatment?