July 14, 2008 / 12:17 AM / 9 years ago

Pledge fails to lift cloud over Fannie, Freddie

6 Min Read

<p>Secretary of the Treasury Henry Paulson announces that the Treasury Department and Federal Reserve will lend money and buy stocks if necessary to aid embattled mortgage lenders Fannie Mae and Freddie Mac during a statement to the media at the Treasury Building in Washington, July 13, 2008.Joshua Roberts</p>

NEW YORK (Reuters) - Buyers showed no hesitation in bidding on Freddie Mac's $3 billion debt sale on Monday, just hours after the U.S. government pledged support for the nation's top mortgage finance agencies, but the steps failed to stem growing alarm on Wall Street.

Global stock markets had rallied after the Treasury Department and Federal Reserve stepped in on Sunday with offers of richer credit lines, equity purchases and direct access to central bank coffers should Freddie and its sister agency Fannie Mae run into deeper financial trouble.

However, stocks quickly shed initial gains as investors feared the steps will do little stem the losses spreading through the financial sector in the wake of a deflating housing market and stalling economy.

Friday's failure of mortgage lender IndyMac Bancorp Inc, the third-largest bank collapse in U.S. history, was a pointed and painful reminder of the financial strains. Shares of a host of banks, including National City and Washington Mutual, fell sharply.

"This incident (with Fannie and Freddie) is not the last one," billionaire investor George Soros told Reuters in a telephone interview, adding that the year-long global market turmoil represented "the most serious financial crisis of our lifetime."

Fannie and Freddie together finance about half of U.S. homes and are seen as vital for stabilizing the worst housing slump since the Great Depression some 80 years ago. But as mortgage defaults rise, even among borrowers with seemingly solid credit, concerns have grown that the two agencies may need more money to cover heavier losses.

Their shares ended lower in a volatile trading day despite the vote of investor confidence exhibited in the debt auction.

"Ultimately, we do not view these (government) measures, dramatic as they look, as either a turning point for the U.S. housing market or as a sign that the downturn will be much worse than previously believed," Goldman Sachs economist Jan Hatzius wrote in a note to clients.

"They simply reaffirm our long-held -- and widely shared -- view that the government will do everything it can to avert a meltdown in the conforming mortgage market and will continue to stand behind the government-sponsored enterprises," he said.

Attention now shifts to Tuesday's hearing of the U.S. Senate Banking Committee, where Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox are expected to join Fed Chairman Ben Bernanke, who was previously scheduled to testify. All three will likely be called upon to detail the Fannie and Freddie proposals.

Congressional Approval

On Sunday, the Treasury Department agreed to raise Fannie and Freddie's credit lines above the existing $2.25 billion each and buy shares to strengthen their finances if needed. The Federal Reserve offered to let the agencies borrow at the rate it charges banks for direct loans.

<p>Secretary of the Treasury Henry Paulson announces that the Treasury Department and Federal Reserve will lend money and buy stocks if necessary to aid embattled mortgage lenders Fannie Mae and Freddie Mac during a statement to the media at the Treasury Building in Washington, DC July 13, 2008.Joshua Roberts</p>

Congress must approve some of those measures. Rep. Barney Frank, the Massachusetts Democrat who chairs the House of Representatives Financial Services Committee, said those provisions would be part of a broader housing bill that is expected to be sent to President George W. Bush for approval by the end of next week.

Frank also said Fannie and Freddie were financially sound, and would probably not need to borrow from the Fed.

Late on Monday, Paulson sent a letter to Bernanke and New York Fed President Timothy Geithner specifying that any lending by the Fed to Fannie and Freddie should be a short-term "bridge" until Congress approves a bigger credit line from theTreasury.

The Treasury Department is seeking Congressional approval for a temporary increase in the credit line it provided for Fannie and Freddie. Its size is to be determined by Paulson, who told the Fed not to lend to Fannie and Freddie until they exhaust their Treasury credit lines.

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Debt buyers seemed confident in the mortgage agencies. Monday's $3 billion debt sale from Freddie drew stronger demand than a similar one on July 7. Fannie announced that it will sell $3 billion worth of debt on Wednesday.

While Monday's debt auction was routine, it was viewed as a key test of market appetite following last week's stock sell-off. Freddie's treasurer said the sale was "business as usual," and he did not perceive a crisis of investor confidence.

The two companies rely on regular debt auctions for funding, and any disruption in the flow of money could push up mortgage rates and deal a fresh blow to a sinking U.S. housing market and fragile economy.

The housing crisis and subsequent credit contraction have prompted banks to tighten lending terms, leaving Fannie and Freddie as the dominant source of mortgage financing.

Fannie and Freddie own or guarantee $5 trillion of debt, close to half the value of all U.S. mortgages. Foreign central banks, mostly in Asia, hold $979 billion of the bonds and mortgage-backed bonds sold by the agencies.

The White House said Fannie and Freddie had not tapped any of the lifelines offered by the Treasury and Fed on Sunday.

"As far as I know, neither of the companies have gone forward to take advantage of any of the borrowing opportunities," White House spokeswoman Dana Perino told reporters. "Both of their regulators have stated that the companies are well-capitalized."

Freddie Mac shares fell 8.3 percent to end at $7.11 and Fannie Mae shed 5.1 percent to close at $9.73. The shares posted both double-digit gains and losses in a volatile session over the span of only a couple of hours.

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