Fannie, Freddie bailout would imperil budget, dollar

By Pedro Nicolaci da Costa - Analysis

NEW YORK (Reuters) - Fannie Mae and Freddie Mac's rapid slide into the center of the global financial crisis has Wall Street frantically talking about a possible government takeover of the government-sponsored mortgage agencies.

But many also worry that a bailout of the GSEs would be so costly that it would cripple the budget and threaten an already badly bruised U.S. currency.

"A perception that the U.S. is no longer a safe haven for capital could produce tremendous strain on the dollar, as would fears of ballooning Treasury commitments associated with a bailout," said James Hamilton, economics professor at the University of California, San Diego.

Together, Fannie and Freddie control nearly half the U.S. mortgage market. The slide in the companies' publicly traded shares has been staggering. Fannie Mae's stock has lost most of its value, swooning from peaks around $70 in August of last year to their current $9.

Freddie has fared even worse. Its shares fell Friday morning to the price of a gallon of gasoline.

Things have become so dire that according to a report in the New York Times, senior Bush administration officials are considering a full-on government takeover.

Treasury Secretary Henry Paulson played down that prospect on Friday, but markets took little comfort in his comments, and the situation remained fluid enough that many are still counting on an eventual bailout.

BLUEPRINT FOR A DOLLAR CRISIS

Such a bold step, unprecedented in scale, would not come without risks. For one thing, the absorption of Fannie and Freddie's liabilities would effectively double the public debt, leaving it at a hefty 65 percent of the gross domestic product.

This could lead to another bout of dollar selling, analysts say, putting an end to the currency's relative calm over the past quarter.

"What is at stake here? The dollar," said Michael Cheah, senior portfolio manager at SunAmerica Asset Management in Jersey City.

A renewed aversion to the greenback, in turn, might revive an old source of anxiety that has so far managed to stay out of the crisis spotlight: the possibility that foreign investors might begin to think twice about holding U.S. government debt.

Overseas central banks own over a quarter of marketable Treasury bonds, and nearly $1 trillion in agency debt.

Standard & Poor's has said the GSEs pose a far greater risk than broker-dealers to the government's AAA credit rating. An S&P analyst also said on Friday that while a Fannie/Freddie downgrade would not necessarily affect the U.S. sovereign debt grade, more generalized problems in the financial sector could.

A run on the dollar would also exacerbate rising inflation, led most visibly by record oil and commodity prices. Reuters/University of Michigan data showed yet another spike in one-year inflation expectations, which climbed to 5.3 percent in July from 5.1 percent in June.