Fannie, Freddie shares sputter after US offers lifeline

July 15, 2008

, WASHINGTON, July 15 – Shares in Fannie Mae and Freddie Mac struggled anew after a near-meltdown last week, as investors mulled a weekend plan offering a government lifeline for the US mortgage finance giants.

Freddie Mac\’s shares shot up as much as 26 percent, Monday but lost steam and closed down 8.3 percent at 7.11 dollars.

Fannie Mae erased its 31 percent opening gain, and then dropped 5.1 percent to end at 9.73 dollars.

The shares had plummeted last week in the face of widening fears about the solvency of the mortgage finance titans and remain down some 75 percent for the year.

"The actions over the weekend don\’t solve our problems in one fell swoop, but right now the stock market is all about psychology, and anything that improves this Armageddon mentality is welcome," said John Wilson, analyst at Morgan Keegan.

A bold plan announced Sunday gives the struggling giants that underpin trillions of dollars in home loans access to Federal Reserve credit and a temporary increase, pending congressional approval, of their lines of credit from the Treasury.

A Fed statement said its Board of Governors had granted the Federal Reserve Bank of New York authority to lend to Fannie Mae and Freddie Mac "should such lending prove necessary."

Meanwhile Freddie Mac was able to sell two billion dollars in three-month notes and one billion in six-month notes. Freddie said the number of bids and yield indicated "solid demand."

Under a plan announced Sunday, Treasury Secretary Henry Paulson proposed temporary authority for the Treasury to purchase equity in either of the two firms "if needed."

Brian Bethune, economist at Global Insight, said the rescue plan needs more concrete measures quickly to stave off a catastrophe for the mortgage giants that could spill over to the wider economy.

"The Treasury will need to specify very soon, within a matter of two or three days, how much capital that it intends to infuse into the two entities," he said.

"This capital infusion needs to be very significant, perhaps as much as 20 billion dollars, or higher, for both entities in order to defuse the speculative selling and reverse the negative psychology quickly and effectively."

Bethune added: "This is not the time for policy makers to underestimate, once again, the systemic risks to the financial system and the huge collateral damage this would impose on the economy."

The two firms, chartered by Congress but owned by shareholders, own or guarantee almost half of all US home loans, or about five trillion dollars of debt, and have been in crisis amid the worst housing downturn in the United States in decades.

David Kotok, economist at Cumberland Advisors, said the plan is "a partial fulfillment of the implied federal guarantee" of the two government-sponsored enterprises (GSEs).

"It reassures markets and improves the liquidity necessary for the functioning of markets in Fannie and Freddie mortgage-related debt," he added.

Ed Yardeni at Yardeni Research said meanwhile: "The taxpayers have become the losers of last resort of the US financial system. If mortgage losses mount at the two GSEs, then the Treasury will issue more debt and use the proceeds to inject more capital into them. The American public now gets a direct stake in the world\’s two largest hedge funds."

Analysts point out that the two firms are needed to help ease the crunch affecting the home loan market.

"The key to gauging the real economy impact is whether these two organizations can continue to provide their services to the mortgage market and ease the continued creation of new mortgages," said Merrill Lynch economist Drew Matus.

The moves on Freddie and Fannie come four months after the Fed acted to defuse a crisis involving Wall Street investment giant Bear Stearns, which resulted in its sale to JPMorgan Chase.

Princeton economist Paul Krugman said Fannie and Freddie "probably will need a government rescue. But since it\’s already clear that that rescue will take place, their problems won\’t take down the economy."

Merrill Lynch analysts said the federal intervention points to the eventual nationalization of the two firms.

"A nationalization of Fannie and Freddie may ultimately result (though in the US, it is called a more palatable \’conservatorship\’). The events of this weekend were the first step in this direction," they wrote in a client note.

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