U.S. mortgage bailout faces tough deadline to end crisis

By Mike Dolan and Burton Frierson - Analysis

NEW YORK/LONDON (Reuters) - The U.S. government bailout of Fannie Mae and Freddie Mac has the potential to break the vicious circle prolonging the year-old global credit crunch, but there is a tight 15-month deadline for the plan to work.

Few analysts expected Sunday's plan by the U.S. Treasury to take control of the mortgage finance giants, which together own or guarantee about half of the country's $12 trillion in mortgages, to turn around the worsening U.S. or global economy overnight.

The initiative appears to be a bold one and includes a plan by the Treasury to begin buying mortgage-backed securities issued by the two companies this month. However, the credit line will only be in place through the end of next year.

This 15-month deadline is critical and it is still unclear whether that will be enough time to foster a U.S. housing market recovery before the mortgage agencies are reduced in size and their future decided in 2010.

"That is part of the pressure and will ultimately be the success or failure of what Treasury has outlined," Kevin Giddis, managing director of fixed income at Morgan Keegan in Memphis, Tennessee, said about the time constraints.

"There are plenty of questions out there and adding the deadline is just going to add to the pressure."

The immediate reaction in financial markets on Monday was exactly what the moribund U.S. housing market will need to begin pulling out of its funk.

Fannie Mae and Freddie Mac bond prices soared and mortgage backed securities (MBS) prices jumped, allowing the 30-year fixed-rate home mortgage rate to fall to near 6.00 percent on Monday from 6.50 percent on Friday, according to Greg McBride, senior financial analyst at Bankrate, Inc, in North Palm Beach, Florida.

Sunday's U.S. government announcement also caused stocks to rise around the world and the U.S. dollar to surge on Monday.

EYE OF THE STORM

However, the plan's deadline could undermine its benefits, some analysts said.

"The lack of clarity about what will happen after 2009 may impair the return of confidence in MBS," said Ciaran O'Hagan, fixed income strategist at Societe Generale in Paris. "The key question now is what happens when the measures of support run out in 2009."

With an economic slowdown now spreading around the world and recession looming in Europe and Japan, the cycle of falling home prices, restricted bank lending, and rising unemployment will take some time to play itself out, but there is no question that the two government sponsored enterprises are at the center of the problem in the U.S.

To the extent that the root of the global credit crisis lies squarely in the drying up of U.S. mortgage finance, then using the U.S. mortgage behemoths as a fountain of liquidity to support the housing market may well work.

"They have short-circuited a potential chaotic development or catastrophe," Kevin Logan, senior U.S. economist at Dresdner Kleinwort in New York, said about Treasury's plan.