Fannie and Freddie debt gains, deep share dive abates

By Lynn Adler

NEW YORK (Reuters) - Investors' growing belief in the likelihood of a federal bailout of home-funding giants Fannie Mae and Freddie Mac triggered a rally in the debt prices of the two companies on Thursday while a steep fall in their shares prices abated.

Debt investors bet the securities will get a U.S. guarantee even if shareholders are wiped out by a federal rescue of the two government-sponsored enterprises (GSEs), which own or back almost half of all outstanding U.S. mortgages.

"The debt is selling right now because the bond market thinks the government is going to step in and take over," said Paul Miller, managing director at Friedman, Billings, Ramsey in Arlington, Virginia. "If the Treasury continues to hold their breath, debt spreads will widen back up" versus Treasuries.

"I do not think it (government intervention) is going to happen this weekend. I do not know if it is going happen within the next couple of weeks," said Miller. "The more the stocks trade down, the higher the probability they will have to act. I do not think $3 is that trigger point, but it is certainly getting there."

Shares of Fannie Mae and Freddie Mac erased earlier losses of about 20 percent as growing speculation of an imminent government bailout forced investors to buy back shares to exit bets made in hopes of a further decline.

Freddie shares fell 2.8 percent to $3.16 while Fannie gained 10.2 percent to $4.85. So far this week, Fannie shares have fallen 39 percent and Freddie is down 46 percent.

The two GSEs have reported losses for the past four quarters, and rising mortgage delinquencies cut into the value of their assets and capital. However, they meet regulatory capital requirements and are successfully rolling over their debt on the regular schedule, limiting the need for any nationalization by the government.

As the nation suffers the worst housing market downturn since the Great Depression, their ability to fund mortgages through the issuance of debt is considered crucial for the housing market and economy.

As the share prices evaporate, banking sector analyst Dick Bove of Ladenburg Thalmann in Florida said the government should recruit financial industry leaders to oversee dismantling of the two companies.

"The only rational action" to be taken relative to Fannie and Freddie "is to get rid of them", Bove wrote in a research note.

The price of the debt issued by Fannie and Freddie has surged relative to U.S. Treasuries in the past two days, however, on the view that Congressional backing for a bailout mandated in July this year will secure repayment.

Investors are closely watching the performance of the companies' debt, given that the two GSEs will need to roll over $225 billion of debt by the end of September, according to Barclays Capital.

"If they are able to roll over their debt in late September, and the dollar amount is substantial, then it signals that the credit markets are comfortable enough with the current situation and with the government backstop and that buys them a fair amount of time," said Brian Gardner, chief political analyst for Keefe, Bruyette & Woods.

"If that does not turn out well, then the Treasury, if they have not already done so, will at that point be forced to step in and act more quickly than they would have," he added.

Both agencies have demonstrated in debt sales this month that they still have ready access to the capital markets, albeit at a higher cost.