China and Japan hail US mortgage bailout

History

China and Japan, the biggest buyers of Freddie Mac and Fannie Mae bonds, praised Washington for its rescue of the ailing mortgage giants, but investors harbored no illusions the bailout would end the global credit market misery.

As battered financial stocks rallied and investors moved out of cash and safe-haven bonds, analysts cautioned that the bailout announced on Sunday was more a sign of the perilous state of the global financial system than of an imminent recovery. “We find it difficult to see how it is bullish that the heavy hand of government is needed to such an extent,” Merrill Lynch economist David Rosenberg said. “In our view, the takeover of Fannie and Freddie is actually a testament to how broken the financial system is at this time.”

China and Japan, the largest and the second-biggest holders of the US lenders’ debt securities welcomed on Monday the US government’s action as good news for investors and the world economy. “I think it will have a positive impact on the world economy as it eases worries over the US economy through more stable financial markets in the United States,” Finance Minister Bunmei Ibuki told reporters on Monday. “Japan welcomes the steps as it removes one unstable factor in the United States, especially because the dollar is a key international currency.”

US Treasury Secretary Henry Paulson would explain the details of the rescue to his Group of Seven counterparts, including Ibuki, on Monday evening, he said. However, US bond futures and US Treasuries fell sharply as it raised concerns the government might have to borrow more. The benchmark 10-year yields jumped 19 basis points to 3.900% as the new trading week opened in Asia. The US dollar rose against the yen but slid against the euro.

The two government-sponsored enterprises, which are publicly traded but which serve a government mission to support housing, were put in a conservatorship that allows their stock to keep trading but puts common shareholders last in line in any claims. The normal powers of the companies’ directors and officers will be held by the conservator, their regulator, the Federal Housing Finance Agency, until the businesses are restored to “safe and solvent” financial health.

US President George W. Bush said the action was necessary because the troubles at Fannie Mae and Freddie Mac, which have $1.6 trillion in debt outstanding, posed “an unacceptable risk to the broader financial system and our economy.” However, US Senate Banking Committee Chairman Christopher Dodd said he planned to hold hearings to examine the government’s decision, saying many questions were unanswered.

 
GOVERNMENT BECOMES SHAREHOLDER

As part of the plan, the Treasury is taking an equity stake in the companies, will purchase mortgage-backed securities they issue and will extend a credit line to them. In addition, the top executives were ousted. Freddie Mac CEO Richard Syron and Fannie Mae’s CEO Daniel Mudd were replaced by David Moffett, a former top official at US Bancorp and Herb Allison, a former top official at both Merrill Lynch and pension fund TIAA-CREF. The Treasury took $1 billion of preferred senior stock in each company but its equity stake could reach as much as $100 billion in each and will be senior to both existing preferred and common shares. The Treasury will also receive warrants to buy up to 79.9% of the common stock.

The Treasury this month will begin buying mortgage-backed securities issued by the companies. The credit line, which will also serve the 12 federal home loan banks, will be in place through the end of next year. The actions reflect a growing willingness of the devoutly free-enterprise Bush administration to get involved in business to help an economy mired in a housing and credit crisis. The plan should help instill some confidence in shaky credit markets and lower mortgage costs, fund managers said.

“By preserving the GSEs in current form -- at least for now -- and injecting sizable billions of dollars into the mortgage market, mortgage rates should come down, and the housing market will be healthier for it,” Bill Gross, manager of Pimco, the world’s largest bond fund, told Reuters. But managers said the rescue was not a cure-all for the global credit market turmoil. “What you have is the US government not putting in immediate cash, but putting its credibility on the line. It’s a tremendous help, but it doesn’t solve all the problems,” said Scott Bennett, a fund manager at Aberdeen Asset Management in Singapore. “This news will likely be displaced going forward by other credit negative news.”

 
TAXPAYERS ON THE HOOK

The Treasury Department said the ultimate cost of the plan depends on how well the companies perform. In July, congressional budget analysts estimated a rescue would likely cost taxpayers $25 billion. The proposals outlined on Sunday, less than two months away from the US election, leave the ultimate fate of Fannie Mae and Freddie Mac in the hands of the next president. “We were given an ultimatum -- do you want to die slowly or do you want to die quickly?” one company source said.

The action, prompted by worries over the companies’ dwindling capital, was the latest in a series of emergency steps taken by US authorities to contain the fallout from the housing sector downturn that has pushed many major economies toward recession. “Our economy and our markets will not recover until the bulk of this housing correction is behind us,” Paulson said. (Reuters)

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