Fannie, Freddie debt soars on government takeover

NEW YORK (Reuters) - Fannie Mae and Freddie Mac debt soared early Monday, hours after the U.S. government's takeover of the two troubled U.S. home funding companies gave explicit backing to their securities.

Confidence engendered by the government's bailout on Sunday spread to other financial products, including some of the riskier mortgage bonds that triggered the U.S. housing meltdown.

Risk premiums on agency-issued debt snapped tighter following the government's draconian action to seize control of Fannie and Freddie, with the aim of stabilizing the worst U.S. housing market since the Great Depression and boost confidence in global financial markets.

"This is the biggest event in my 21 years in the business," said Arthur Frank, director and head of MBS research at Deutsche Bank Securities in New York.

The market was heartened by the plan for Treasury to buy Fannie and Freddie mortgage-backed securities.

"Today's tightening is definitely one of the most, if not the most, tightening the market has ever seen," Frank said. "Demand is coming from both domestic and overseas investors."

Most U.S. agency note and mortgage bond spreads sliced away more than 20 basis points on the clear confirmation that Fannie and Freddie debt is government-backed.

China and Japan, the biggest buyers of Freddie Mac and Fannie Mae bonds, on Monday praised Washington for rescuing the troubled mortgage titans, bolstering market confidence about ongoing foreign investment in these securities.

Freddie Mac tested the issuance waters with its first bill sale since the takeover. The $2 billion of new securities drew much heavier demand at much lower interest rates than for the same amount of bills sold a week ago.

Fannie Mae is scheduled to announce its September note borrowing plans later on Monday.

The company's existing five-year notes yielded about 62 basis points more than Treasuries, down sharply from 99 basis points on Friday, a trader said.

Fannie's 30-year 5-1/2 percent mortgage bonds yielded 1.593 percentage point more than Treasuries on Monday, compared with 1.944 point on Friday, according to data compiled by Reuters. At the year's outset the risk premium was 1.475 point.

Ginnie Mae mortgage-backed securities on Monday, meanwhile, gained in price but lost virtually all their advantage to Fannie and Freddie mortgage bonds after the government backed the two companies.

Ginnie Mae had been the only mortgage bond issuer whose loans had a full government guarantee, making their securities more valuable than those issued by Fannie Mae and Freddie Mac.

The price premium on Ginnie Mae bonds paying 6 percent interest dropped to 2/32 early Monday from 16/32 on Friday. The premium had been as high as 1-10/32 earlier this year as the credit crisis turned risk-averse investors to Ginnie Maes.

Even the riskier bonds that helped jar U.S. housing strengthened on Monday.

Key indexes containing subprime mortgage bonds jumped 2 to 4 points in price early Monday to levels not seen since June after the government's action on Sunday.

"Certainly we've seen compression in a variety of indexes and cash bond spreads," a Citigroup analyst said on a conference call on Monday "We do expect that as initial reaction given the optimism that this move has generated."

Separately, the government's takeover will trigger one of the largest ever payments in the credit default swap market, analysts said on Monday.

It is the first time a company in the benchmark investment-grade credit derivative index has had a credit event, JPMorgan analyst Eric Beinstein said in a report on Monday.

Protection sellers on Fannie Mae and Freddie Mac's senior debt are unlikely to experience large losses, however, as the debt underlying the swaps is trading near or above its par value.

(Additional reporting by Al Yoon, Julie Haviv, Rodrigo Campos, Karen Brettell, Editing by Chizu Nomiyama)