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Fannie, Freddie Worries Drive Down Markets

By Renae Merle
Washington Post Staff Writer
Saturday, July 12, 2008

A volatile week on Wall Street ended yesterday with U.S. stocks bouncing between negative and positive territory on concerns about the stability of mortgage industry giants Fannie Mae and Freddie Mac.

The Dow Jones industrial average spent most of the day down more than 200 points, falling below 11,000 twice. The market sprinted back into positive range at about 3 p.m., when some news outlets reported that Fannie Mae and Freddie Mac, which have sustained significant loses related to the mortgage crisis, would be allowed to borrow from the Federal Reserve's discount window. When the Fed knocked down that report, trading fell back into negative territory to close the day.

The week's uneven trading is evidence that the country is still mired in a financial crisis, said Nigel Gault, economist for Global Insight, a research firm in Lexington, Mass. "I am not sure the underlying realities have shifted. It's the perceptions that are catching up to the reality," he said.

The Dow Jones lost 128.48 points, or 1.14 percent, to close at 11,100.54, and the broader Standard & Poor's 500-stock index fell 13.90 points, or 1.11 percent, to 1239.49. The tech-heavy Nasdaq composite index lost 18.77 points, 0.83 percent, to close at 2239.08.

The questions swirling around Fannie Mae, which is based in the District, and Freddie Mac of McLean consumed Wall Street, with the stock price of each tumbling 50 percent early yesterday, even as Treasury Secretary Henry M. Paulson Jr. attempted to assure investors that the two companies could survive the current economic storm.

"Paulson was trying to be reassuring. It would have almost been better if he had said nothing," said Ed Yardeni, chief investment strategist for Yardeni Research.

Investors concluded that expanding Fannie Mae's and Freddie Mac's borrowing capability would not cure their underlying problems, analysts said. "That helps with a short-term problem," Gault said. "It doesn't do anything to alter the loses they have suffered or will suffer that will wipe out their capital."

Fannie Mae shares ended the day down 22 percent, while Freddie Mac lost 3 percent.

"Investors are saying we're not going to provide capital that's necessary to restructure their balance sheet. The government is going to have to step in and do it," Yardeni said.

Concerns about Fannie Mae and Freddie Mac dragged down others in the financial services sector. Lehman Brothers' shares fell 17 percent, and Wachovia dropped 12 percent.

Also helping fuel market turbulence, oil spiked to a new record of $147 per barrel early yesterday before settling at $145.08 a barrel, up $3.43.

Investors remain concerned about oil shipment disruptions, particularly if tensions continue between Israel and Iran, which has the second-largest oil reserves in the world. Iran test fired missiles capable of striking Israel earlier this week. Also, this week, a militant group in Nigeria, another major oil exporter, called off a cease-fire in that country, spurring more fears.

Neither appear to be realistic challenges to global oil supplies, but that has not stopped rampant speculation that has sent jitters through investors, analysts said. "If it is not Iran, it is Nigeria. If it is not Nigeria, it will be the weather. It will always be something," said Fadel Gheit, an oil analyst with Oppenheimer.

Increasing oil prices have also provided a safe cushion for investors skittish about the financial sector, analysts said. "What else is there to invest in? What else is going up these days?" said James Williams, an economist at energy research firm WTRG Economics.

The market turbulence overshadowed an unexpected drop in the trade deficit announced by the Commerce Department yesterday. The trade gap narrowed in May to $59.8 billion from $60.5 billion, as petroleum imports fell 10.5 percent. Even taking into consideration weaker U.S. demand for gasoline, which dampened the need for imported oil, import volumes were exceptionally low in May, said Gault of Global Insight.

Gault added that "it looks like it was a positive signal" that the economy grew 2 percent in the second quarter. "The fear is what happens in the future if the financial crisis deepens, if the credit crunch deepens," he said. "Then the concern is that this could be the last time we see 2 percent [economic] growth for a long time."

Some reassuring news come from conglomerate General Electric, which reported a 5.8 percent drop in profit during its second quarter yesterday, in line with analysts' expectations. The company earned $5.07 billion, or 51 cents a share, on revenue of $46.89 billion. Investors have also been buoyed by the news that GE may spin off its consumer unit, which includes light bulbs. GE's shares stayed stable in trading, up 7 cents.

"It's not as bad as it could have been. That is the way to sum up market reaction to GE" earnings, said Joseph Brusuelas of Merk Investments.

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