United States

Asian shares rally over Fannie, Freddie bailout

Monday 08 September 2008

Asian shares rallied in response to the US treasury's announcement of a bailout for mortgage finance companies Fannie Mae and Freddie Mac. The U.S. stock index is expected to soar when when Wall Street opens on Monday.

WASHINGTON - The U.S. government on Sunday seized control of mortgage finance companies Fannie Mae and Freddie Mac, launching what could be its biggest bailout ever to support the U.S. housing market and ward off more global financial market turbulence.

The action, prompted by worries over the companies' shrinking capital, was the latest in a series of emergency steps taken by U.S. authorities to quell what is now a year-long credit market crisis that has helped push many economies toward recession.

"Our economy and our markets will not recover until the bulk of this housing correction is behind us," U.S. Treasury Secretary Henry Paulson said in a statement.

Fannie Mae and Freddie Mac, which own or guarantee almost half of the country's $12 trillion in outstanding home mortgage debt, were so large that "a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Paulson said.

The congressionally chartered companies, the two largest sources of U.S. housing finance, have suffered combined losses of nearly $14 billion in the last four quarters and large holders of their debt, including overseas central banks, have shown increasing nervousness over their health.

Japan, the world's second biggest economy flirting with a recession, said the U.S. move should help the global economy.

"Japan welcomes the step as it removes one unstable factor in the United States, especially because the dollar is a key international currency," Finance Minister Bunmei Ibuki told reporters. He said Paulson would explain the details of the rescue to his Group of Seven counterparts, including Ibuki, on Monday evening.

U.S. stock index futures surged on Sunday evening, signalling a sharp rise when Wall Street opens on Monday. Asian shares soared 4 percent at the start of the new trading week, showing the plan had shored up investor sentiment.

However, U.S. bond futures and U.S. Treasuries fell sharply as it raised concerns the government might have to borrow more. The benchmark 10-year  yields jumped 19 basis points to 3.900 percent as the new trading week opened in Asia.

The U.S. dollar rose against the yen but slid against the euro.

The two government-sponsored enterprises, which are publicly traded but which serve a government mission to support housing, were put in a conservatorship that allows their stock to keep trading but puts common shareholders last in line in any claims.

The normal powers of the companies' directors and officers will be held by the conservator, their regulator, the Federal Housing Finance Agency, until the businesses are restored to "safe and solvent" financial health.

U.S. President George W. Bush said the action was necessary because the troubles at Fannie Mae and Freddie Mac, which have $1.6 trillion in debt outstanding, posed "an unacceptable risk to the broader financial system and our economy."

However, U.S. Senate Banking Committee Chairman Christopher Dodd said he planned to hold hearings to examine the government's decision, saying many questions were unanswered.

GOVERNMENT BECOMES SHAREHOLDER

As part of the plan, the Treasury is taking an equity stake in the companies, will purchase mortgage-backed securities they issue and will extend a credit line to them.

In addition, the top executives were ousted. Freddie Mac chief executive Richard Syron and Fannie Mae's CEO Daniel Mudd were replaced by David Moffett, a former top official at US Bancorp and Herb Allison, a former top official at both Merrill Lynch and pension fund TIAA-CREF.

The Treasury took $1 billion of preferred senior stock in each company but its equity stake could reach as much as $100 billion in each and will be senior to both existing preferred and common shares. The Treasury will also receive warrants to buy up to 79.9 percent of the common stock.

The Treasury this month will begin buying mortgage-backed securities issued by the companies. The credit line, which will also serve the 12 federal home loan banks, will be in place through the end of next year.

The actions reflect a growing willingness of the devoutly free-enterprise Bush administration to get involved in business to help an economy mired in a housing and credit crisis. The plan should help instill some confidence in shaky credit markets and lower mortgage costs, fund managers said.

"By preserving the GSEs in current form -- at least for now -- and injecting sizable billions of dollars into the mortgage market, mortgage rates should come down, and the housing market will be healthier for it," Bill Gross, manager of Pimco, the world's largest bond fund, told Reuters.

But managers said the rescue was not a cure-all for the global credit market turmoil.

 "What you have is the U.S. government not putting in immediate cash, but putting its credibility on the line. It's a tremendous help, but it doesn't solve all the problems," said Scott Bennett, a fund manager at Aberdeen Asset Management in Singapore. "This news will likely be di splaced going forward by other credit negative news."

TAXPAYERS ON THE HOOK

The Treasury Department said the ultimate cost of the plan depends on how well the companies perform. In July, congressional budget analysts estimated a rescue would likely cost taxpayers $25 billion.

The proposals outlined on Sunday, less than two months away from the U.S. election, leave the ultimate fate of Fannie Mae and Freddie Mac in the hands of the next president.

Democratic presidential contender Sen. Barack Obama said it would be necessary to clarify whether they are truly public companies, subject to market discipline, or special entities that investors feel they can put money in risk-free.

A senior adviser to Republican presidential nominee Sen. John McCain described them as examples of "crony capitalism" and said McCain believed they should eventually be privatized.

Foreign central banks reduced their holdings of "federal agency" debt in custody at the Federal Reserve in the past week for the seventh week in a row.

Paulson said information on the companies' capital gained over the past four weeks led him to conclude officials needed to act. The Treasury hired Morgan Stanley on Aug. 5 to advise on whether the companies were adequately capitalized.

FHFA Director James Lockhart said the companies lacked sufficient capital to support the housing market at a time they were suffering big losses.

"As house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated," he said. "They have been unable to provide needed stability to the market."

Ben Bernanke, Chairman of the Federal Reserve -- the U.S. central bank -- strongly endorsed the action. "These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets," he said.