Mortgage takeover promises no quick housing fix

NEW YORK Sun Sep 7, 2008 4:48pm EDT

Secretary of the Treasury Henry Paulson (R) listens as Jim Lockhart, Director of the the new independent regulator, the Federal Finanace Agency (FHFA), speaks during a news conference, announcing that the government is taking control of mortgage finance companies Fannie Mae and Freddie Mac, at the Office of Management Supervision in Washington, DC, September 7, 2008. REUTERS/Joshua Roberts

Secretary of the Treasury Henry Paulson (R) listens as Jim Lockhart, Director of the the new independent regulator, the Federal Finanace Agency (FHFA), speaks during a news conference, announcing that the government is taking control of mortgage finance companies Fannie Mae and Freddie Mac, at the Office of Management Supervision in Washington, DC, September 7, 2008.

Credit: Reuters/Joshua Roberts

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NEW YORK (Reuters) - Washington's latest attempt to resuscitate the moribund U.S. mortgage business moves the housing market out of the emergency room and into intensive care but by no means cures the patient.

The U.S. government announced on Sunday it was seizing control of troubled mortgage finance giants Fannie Mae and Freddie Mac, which are vital to the U.S. housing industry and have posed risks to international investors.

The action should lend stability after a year of turmoil in financial markets, and is sure to be watched closely by other victims of deflated housing bubbles, such as the UK. But there is still a long way to go to right the U.S. economy.

"This is a slow process. This is a baby step in the right direction," William Larkin, fixed income portfolio manager at Cabot Money Management in Salem, Massachusetts, said about the plan's effect on housing and the economy.

Larkin added that "it is going to be a positive for our financial system."

Anything that puts U.S. growth on a firmer footing is likely to raise hopes for the struggling global economy, though it could raise risks of already elevated U.S. inflation if investors grow to view this as the government printing money to bail out the economy.

VITAL SUPPORT

U.S. financial officials have made clear that a recovery in the housing market, currently in its worst slump since the Great Depression, was vital to getting the economy back on its feet. That's because so much of consumers' total wealth is tied to the value of their homes that staunching declining property prices is a must before any rebound in consumer spending can be expected to take hold.

They cited concern about the housing market when announcing the takeover of Fannie Mae and Freddie Mac, which own or guarantee almost half of the country's $12 trillion in outstanding home mortgage debt.

Their combined losses of nearly $14 billion in the last four quarters had led to concerns they could no longer buy mortgages, to package and resell, with their usual vigor.

In normal times, this greases the market's wheels by allowing lenders to continue extending credit for new purchases of homes, which in turn boosts related businesses, from construction firms to producers of furniture and appliances.

Anything that hinders Fannie and Freddie's participation in the market threatens to bring this virtuous economic circle to a grinding halt.

Since the mortgage market erupted into crisis last year, the economy has stalled as banks clamped down on credit to business and cash-strapped consumers.

Feeling the pinch, U.S. employers cut jobs for the eighth consecutive month in August, boosting the national unemployment rate to a five-year high of 6.1 percent.

Meanwhile, the euro zone economy suffered a contraction in the second quarter while Japan is also thought to be on the brink of a recession or already in one.

"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 at a news conference on Sunday. "Fannie Mae and Freddie Mac are critical to turning the corner on housing."

However, the takeover, which could amount to the largest financial bailout in U.S. history, will have only a slow effect on the economy due to the enormity of housing's decline.

Since their peak in 2006, house prices have fallen by nearly 20 percent. The supply of homes for sale has also burgeoned a result of the building boom and mass speculation on house-price appreciation.

The slump has also left many borrowers with more debt than their homes are now worth, and analysts say Treasury's plan will not change this in the short term.

"It's not going to address declining house prices," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

CRAVING STABILITY

Still, if the takeover at least stabilizes housing and financial markets -- something previous government efforts have failed to do -- it will establish the necessary conditions for recovery, however slow a process that may be.

This will allow banks and other firms to get on with the painful business of writing down their losses from the housing bust. By restoring confidence it should also bring down mortgage rates so previous home buyers can refinance into cheaper loans and new ones can enter the market.

"Until we can stop the hemorrhaging in housing, the economy and fixed income, the markets will not be able to recover," said Stephen Wood, senior portfolio strategist at Russell Investments in New York. "The best line today: this is a time out."

(Additional Reporting by Elinor Comlay, Richard Leong and Lynn Adler; Editing by James Dalgleish)

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