GSE rescue could scare bears

By Steven C. Johnson

NEW YORK (Reuters) - Bears have reigned supreme on Wall Street so far in September thanks to growing concern about economies worldwide, but their grip on stocks faces a big challenge after the U.S. government's weekend seizure of control of mortgage finance giants Fannie Mae and Freddie Mac.

Since late spring stocks have been caught in a vise of investor anxiety about the fate of the two linchpins of the U.S. mortgage market, which between them own or guarantee more than half of the $12 trillion outstanding U.S. home loans.

With home prices continuing to spiral lower, Fannie Mae's (FNM.N) and Freddie Mac's (FRE.N) losses deepening by the week and sources of fresh private capital increasingly scarce, investors worried that any collapse of the two would trigger a global financial catastrophe.

But analysts said Sunday's move to place them under government control should alleviate worry about the worst-case scenario and removes a veil of uncertainty that markets loathe.

"It's probably a good move for the markets in the short term," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

"I think the stock market is going to take this as a positive," agreed William Larkin, fixed income portfolio manager at Cabot Money Management in Salem, Massachusetts.

"It's going to hurt Treasuries because that flight to quality that was occurring will probably go the opposite direction."

"The government is going to be basically pulling a lot of this stuff onto the U.S. government's balance sheet and that may be a concern for the dollar, but it is going to be a positive for our financial system," Larkin said.

The early reaction in equity derivatives markets dovetailed with that view. Standard & Poor's 500 equity index futures surged late Sunday when they opened trading for the week, pointing to gains when Wall Street opens on Monday morning.

The government decision to place Fannie Mae and Freddie Mac in conservatorship will not provide universal relief, however. Their common shareholders are likely to be left with little value, and preferred shareholders will also take a hit, a move that could hurt a number of small banks with preferred holdings that are significant relative to their overall capital.

Still, U.S. regulatory agencies said "they are prepared to work with these institutions to develop capital-restoration plans pursuant to the capital regulations."

It also remains unclear how successful the government action would be in shoring up the broader economy, which has been in the doldrums for the last year largely as a result of the worst U.S. housing market since the Great Depression.

Recent data that showed the U.S. economy continues to shed jobs and warnings from a raft of companies about diminished global demand slammed equity markets over the past week.

The three main U.S. indexes lost more than 2.8 percent each, with the S&P 500 coming perilously close to a 2008 low set in mid-July. European and Asian markets also fell sharply.

Markets have struggled even as the price of oil has continued a steady slide, down about 27 percent from its July record above $147 a barrel. While positive for consumers, lower oil prices are also a symptom of slowing global demand.