Markets wary after Fannie and Freddie bail-out

Financial Times | Last updated: September 8 2008 19:22 (Londres)

By Michael Mackenzie in New York and Krishna Guha and Andrew Ward in Washington

Financial markets gave an initial vote of confidence to the US Treasury’s in effect nationalisation of Fannie Mae and Freddie Mac on Monday, but investors grew more cautious later and share prices surrendered some of their early gains.

The plan announced on Sunday by Hank Paulson, Treasury secretary, received broad support from congressional leaders, but it remains unclear how much it would change the outlook for the US housing market and the economy.

Chris Dodd, chairman of the Senate banking committee, said there were still “many unanswered questions” about the plan.

“Americans need to know if this plan will alleviate, not deepen, our current economic problems,” he said.

Mr Paulson said the discussions over how to prop up Fannie Mae and Freddie Mac were “all consuming”’ in recent weeks, when he was forced to make a decision he would rather have avoided.

“This is the first time in my career I had trouble sleeping, and it wasn’t because it was a difficult decision,” Mr Paulson told Bloomberg television. “Government intervention is not something that I came here wanting to espouse, but it sure is better than the alternative.”

Global equities rose sharply at first but, in afternoon New York trade, the rally was losing steam.

The S&P500 was up 0.8 per cent, down from an opening surge of 2.6 per cent.

Financials led out of the gate with a rise of 6.2 per cent, only to pare that back to a rise of 1.4 per cent. A surge of buying sent yields on mortgage-backed securities lower across the board.

Yields on mortgage bonds and debt issued by Fannie and Freddie fell particularly sharply, raising the promise of lower rates on home loans backed by the companies. However, Fannie and Freddie shares plunged more than 80 per cent to less than $1 as investors judged that the Treasury plan would all but wipe out the common equity.

Some measures of systemic risk eased – indicating the US move was helping to reduce stress in the global financial system – but remained at high levels. In a reminder of the troubles still plaguing the financial sector, shares in Lehman Brothers fell 18.5 per cent as investors worried that it would not be able to raise more capital ahead of its earnings report this month.

Elsewhere, stocks closed out strongly with London’s FTSE100 near its high for the day, up 3.9 per cent. The FTSE Eurofirst 300 climbed 3.2 per cent. Asian stocks were mainly higher across the board as Japan rose 3.4 per cent, while Hong Kong gained 4.3 per cent.

Trading was volatile in the US fixed-income markets. The yield on Fannie Mae mortgage bonds fell 0.3 percentage points.

Dominic Konstam, head of interest rate strategy at Credit Suisse, said: “Foreign holders of agency debt and mortgages should be happy with this move by the Treasury.”

Technical factors made it difficult to assess the ultimate impact of what could end up being a giant bail-out on the US government’s own borrowing costs.

The yield on the 10-year Treasury note initially jumped above 3.85 per cent, but fell back to 3.72 per cent, reflecting hedging strategies in which investors seek a balance between their mortgage holdings and the general level of rates.

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