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Rescue of Fannie, Freddie calms markets for now

A US government plan to shore up mortgage finance firms Fannie Mae and Freddie Mac helped calm markets on Monday but did little to allay fears about the health of the US financial system.

The US Treasury and Federal Reserve plan, announced on Sunday evening, called for sweeping measures to lend money and buy equity if necessary in Freddie Mac and Fannie Mae, government-sponsored (GSE) enterprises owned by shareholders.

The plan was hatched in an attempt to calm investors after stocks of both plummeted more than 40% last week on fears the companies, pillars of the housing market, were under capitalised and the credit crisis toppled a fifth US bank.

Fannie and Freddie own or guarantee $5-trillion of debt, close to half the value of all US mortgages. Foreign central banks, mostly in Asia, hold $979-billion of the bonds and mortgage-backed bonds sold by the agencies.

”[Their] continued strength is important to maintaining confidence and stability in our financial system and our financial markets,” US Treasury Secretary Henry Paulson said in a statement that he read on the steps of the Treasury building.

”Therefore, we must take steps to address the current situation as we move to a stronger regulatory structure,” he said.

The dollar jumped and stock futures rallied on the powerful message of support from Washington, which also drew criticism for being a potential bailout that could cost US taxpayers dearly.

Asian stock markets were mixed, with shares in China and Japan higher but lower elsewhere as investors grappled with the implications for the financial sector. Japanese government bond futures fell, tracking a drop in Treasuries.

”Steps to shore them up is a positive but the fact that they are having difficulties in the first place is just symptomatic of a difficult environment out there. And that makes it hard to get too positive,” said Greg Goodsell, equity strategist with ABN AMRO in Sydney.

Bill Gross, who manages the $130-billion Pimco Total Return Fund, said while this does not explicitly guarantee the bonds of Fannie Mae and Freddie Mac, ”it tells the market that the government will not allow them to fail”.

Gross also said that substantial changes in regulation lie ahead for Fannie and Freddie, and if such changes are adopted ”agency securities will begin to look more like Treasuries in terms of yield and credit quality, as will the mortgages that bear their name”.

Unveiling the emergency measures to calm markets roiled by the country’s prolonged housing crisis, the Fed said Fannie and Freddie could have access to its emergency cash, echoing a move to support investment banks after the Fed organised a takeover of ailing investment bank Bear Stearns in March.

The Treasury separately said it would temporarily raise its line of credit to the two mortgage financiers, as well as purchase equity in them, a step never taken before, if needed.

Both companies said they were adequately capitalised, but welcomed the measures and said they would help confidence.

Nerves on edge
Officials are desperate to calm nerves ahead of a crucial debt issue by Freddie Mac on Monday and after US bank regulators on Friday seized mortgage lender IndyMac Bancorp in the third-largest bank failure in US history.

A senior Treasury official said all the actions it proposed need congressional approval, but expressed confidence that could be secured this week.

A spokesperson for speaker of the House of Representatives Democrat Nancy Pelosi said she would work with the Republican administration of President George Bush on this matter.

Democrats in the Senate also said they stood ready to work with the administration on quickly addressing the problems faced by the mortgage companies.

Shares in the two mortgage giants have been hammered by concerns that they might run out of capital amid mounting home-loan losses.

Weight on economy
Housing woes have forced the Fed to slash benchmark interest rates since September and open its discount window to investment banks for the first time since the great depression about 80 years ago.

Fannie and Freddie buy mortgages from lenders and package them into guaranteed securities, providing more funds to keep mortgage markets lubricated.

They also borrow regularly on capital markets to fund their operations and one investor predicted Freddie’s planned auction of $3 billion in three- and six-month notes on Monday would go well.

Dan Fuss, vice-chairperson of Boston-based Loomis Sayles, which oversees more than $100-billion in fixed-income securities, also said he had been buying Fannie and Freddie paper in recent days because it was ”outstanding value”.

Freddie and Fannie debt rallied sharply on Friday as investors bet they would get closer government backing and analysts said that this was in fact happening.

”Fannie Mae and Freddie Mac have never been more related to the US government,” said Margaret Kerins, US agency strategist at RBS Greenwich Capital in Chicago.

But Fannie and Freddie’s shares have been savaged in recent days and reduced to a fraction of their value a year ago and analysts remain sceptical.

The two companies play a vital role in US housing markets, which already are experiencing their deepest downturn since the great depression, and the Treasury and the Fed are on the spot to make sure they do not put a sorely stressed financial system in worse shape than it is already in.

Many fear that were they to fail it would unhinge already battered world financial markets and inflict a deep recession in the United States that would chill growth everywhere.

Treasury said its temporary increase in the line of credit that the GSEs now have with Treasury, would be up to an amount to be determined by Paulson. The current credit line for each lender is $2,25-billion.

In addition, ”to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed,” Paulson said. – Reuters

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