"Free market" Wall St warms up to govt help

NEW YORK (Reuters) - When market forces go terribly awry, not even the free-market champions on Wall Street are too proud to accept a helping hand from the government.

When the Bush administration stepped into the country's mortgage mess, it framed the effort as a plan to help the little guy.

However, analysts say the move's real aim is to revive credit markets, whose paralysis threatens to push the economy into recession.

Home defaults have been rising for some time, they note. But it was only when the staggering scale of investors' bad bets on mortgage-linked bonds became fully apparent -- in the form of massive losses for big banks -- that politicians started paying attention.

"Regardless of what spokespeople are saying there is an inherent interference with the principles of a free market," said Carley Garner, analyst at Alaron Trading in Las Vegas.

Yet far from shunning the heavy hand of government, Wall Street cheered the president's proposal with a huge rally in stocks.

"Paulson and the administration provided important symbolism that this is a problem that's being handled," said Tony Crescenzi, chief bond market strategist at Miller, Tabak & Co. "Finally there's something to combat this problem."

Financial company shares, which had taken a beating in recent months as estimates of possible debt losses for the large banks skyrocketed into the hundreds of billions, recovered smartly.

Still, skepticism has emerged. Many argue it will be difficult to distinguish legitimate need from speculative excess, and that the group that the proposal will help is too small to put a dent in the crisis.

SOCIALIZED HOUSING

Then there are those who are doubtful on purely ideological grounds.

"We're socializing housing finance," said Michael Feroli, economist at J.P. Morgan.

Apart from the newly unveiled measure, there have been massive loans by the government-backed Federal Home Loan Bank that some, including New York Democratic Senator Charles Schumer, have flagged as potentially dangerous.

FHLB loans, which are granted with these mortgage bonds as collateral, skyrocketed to a record $746.2 billion in the third quarter alone, nearly 18 times the yearly average between 2003-2006.

The White House was quick to emphasize that no federal money is at stake in the plan the U.S. Treasury Department helped hammer out to temporarily freeze interest rates on some subprime mortgages facing big payment resets. The government, it argued, was just bringing lenders and borrowers together to reach a suitable compromise.

Yet experts note the mortgages themselves are not the source of the problem. Instead, they point at Wall Street's propensity for generating highly complex bonds out of home loans -- until recently, the quintessential brick-and-mortar investment.

The politicians and regulators now orchestrating the rescue also deserve some blame, say analysts. A bipartisan push for banking deregulation over the past 15 years allowed banks to expand so much that oversight became more difficult.

Many also say the Federal Reserve's decision to hold interest rates at rock bottom levels for so long encouraged the kind of excess risk-taking now coming home to roost.

Government involvement in financial crises is not new. The Fed played a key role in warding off the panic that followed the 1998 meltdown of mega-hedge fund Long-Term Capital Management, and taxpayers footed the bill for the savings and loan crisis of the 1980s.

As usual, Wall Street's embrace of a government-led solution is at best uncomfortable, and many fear an environment where greater regulation takes a toll on the ability of banks to sustain the record profits of recent years.

"What gets me concerned is all the talk about solutions that would involve the government enacting regulations or legislation that would either interfere with contractual obligations that are already out there or governments getting involved in banning certain types of loans going forward," said Chuck Webber, a finance lawyer with Fagre & Benson in Minneapolis.

(Additional reporting by Tamawa Kadoya, Editing by Chizu Nomiyama)