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US Nationalizes Fannie Mae & Freddie Mac - Outcome Uncertain (NYT)

Originally posted on sciy.org by Ron Anastasia on Mon 08 Sep 2008 01:00 AM PDT  



A Sigh of Relief, but Hard Questions Remain

Published: September 8, 2008

Investors around the world breathed a sigh of relief on Monday after the federal government took over and backed Fannie Mae and Freddie Mac, assuring a continued flow of credit through America’s wounded mortgage system.

Asian stock markets rallied at the opening on Monday after the Treasury’s announcement to transfer of control of Fannie Mae and Freddie Mac to conservatorship. The Tokyo market rose 2.8 percent and Australia’s market jumped 3.2 percent.

Futures contracts on the Standard & Poor’s 500-stock index jumped more than 2 percent in early Asian trading as investors concluded that the Bush administration’s decision over the weekend had strengthened the prospects for American businesses, particularly banks, and for the American economy.

The dollar and yen weakened against the euro and the British pound by late Monday morning in Asia as investors halted their recent flight to the safety of the dollar and yen and began to conclude that European economies might not be in as grave danger as they had seemed last week.

But the takeover of the companies reinforced concerns about troubles of the American economy and highlighted its significant reliance on foreign investors, particularly in Asia.

Almost immediately, the move will protect central banks in Asia, which have amassed hundreds of billions of dollars of Fannie Mae and Freddie Mac bonds, from taking big losses. The move should also bode well for American financial institutions and, in the short term, the broader stock market.

As policy makers looked to the start of trading in Asia on Monday, investors said they expected the spread between Treasury securities and comparable Fannie Mae and Freddie Mac debt to shrink drastically, reflecting renewed faith about the safety of the market.

In recent months that spread, or premium, had ballooned significantly, eroding confidence in the health of the companies. Before the housing crisis, Fannie and Freddie could borrow money at a small premium over the federal government’s rates. “If it becomes like U.S. Treasuries, that is a positive for Asia,” said Ifzal Ali, the chief economist of the Asian Development Bank in Manila.

Treasury’s purchase of mortgage securities may help lower interest rates on home loans, which this summer rose to their highest level in a year. That reduction in housing costs should help cushion the decline in home prices, which have already fallen more than 18 percent from their peak in the summer of 2006, said Bill Gross, the co-chief investment officer of Pimco, the large bond investment firm.

“It goes a long way to stopping this housing deflation which, I think and Pimco thinks, is at the heart of the problem,” he said.

But the plan also raises a host of questions about the fragility of the American economy, which will continue to figure into investor calculations. On Friday, for instance, the Labor Department reported that the unemployment rate climbed to a five-year high of 6.1 percent.

Perhaps most important, despite the government support for Fannie Mae and Freddie Mac, any stabilization in home prices is still a way off, and the waves of foreclosures battering the housing market are not likely to reverse right away. What is more, the plan will do little to stem losses in risky home loans, commercial mortgages and debt used by private equity firms to acquire companies. Financial institutions have already taken write-downs of $500 billion and the International Monetary Fund projects that losses could reach $1 trillion.

“It’s a good half a plan, but its still just half a plan,” said Joseph Mason, a finance professor at Louisiana State University, who cautioned that the government needed to outline its longer-range plan for the two companies and the credit markets to restore greater confidence to markets.

Yet for foreign investors, particularly in Asia, the takeover will do little to assuage mounting fears that the economic problems in the United States are not only far from over, but could also hurt growth in China, India and other emerging economies.

“People don’t know about the depth of the problem,” Mr. Ali said.

Asian central banks, particularly the People’s Bank of China, have emerged over the last several years as important buyers of bonds from Fannie Mae and Freddie Mac, the two American government-sponsored enterprises.



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