Stock Markets Soar After Freddie, Fannie Bailouts

The Bush administration, acting to avert the potential for major financial turmoil, says the federal government was taking control of mortgage giants Fannie Mae and Freddie Mac. (Sept. 7) Video by AP
By Howard Schneider and Ariana Eunjung Cha
Washington Post Staff Writers
Monday, September 8, 2008; 5:11 PM

U.S. stock markets surged higher today as investors expressed confidence that the government's weekend seizure of Fannie Mae and Freddie Mac would bolster the slumping U.S. housing and mortgage markets.

Shares in the companies themselves, meanwhile, plummeted toward penny stock range, undermined by a government takeover that puts the rights of bondholders and the U.S. Treasury above those of common and preferred stockholders. Shares in both companies each fell by more than 80 percent. Freddie ended the day at 88 cents a share, an 83 percent decline, and Fannie closed at 73 cents, a 90 percent decline.

Following rallies that pushed Asian and European indexes up as much as 4.5 percent, the Dow Jones industrial average jumped more than 330 points in early trading and closed up 290 points at 11,511. That was a 2.6 percent gain for the day.

The Standard & Poor's 500-stock index was also up about 2 percent with a 25-point rise to 1,268.

The Nasdaq composite index climbed 14 points to 2,270, a more modest gain of 0.6 percent.

The rally provided at least an initial vote of confidence in the plan announced yesterday by Treasury Secretary Henry M. Paulson Jr. to place the two mortgage giants into a government-managed conservatorship while a longer-term restructuring is ironed out. Central bankers in Beijing and Tokyo -- important buyers of U.S. mortgage-backed debt -- also came out in support of the takeover, which includes U.S. government guarantees that their billions of dollars in bonds will be repaid.

In an interview on CNBC this morning, Paulson said seizing control of the two companies was "not something I wanted to do" but was unavoidable given the havoc the failure of either firm would have caused to the U.S. and global economies. Fannie and Freddie are critical to the functioning of U.S. mortgage markets, but there have been growing doubts about their ability to fill that role.

"This is not something you are happy about," Paulson said, but "it was better than the next best alternative."

Stock markets, however, were ecstatic, with shares in banks and financial companies leading major world indexes sharply higher. On Wall Street, Citigroup and Bank of America were up as much as 10 percent at one point.

The financial sector has been hit hard by rising U.S. mortgage defaults, with companies trimming tens of billions of dollars from their balance sheets to account for the falling estimated value of mortgage-backed investments.

By boosting hopes of a stabilized U.S. mortgage market, the takeover of Fannie and Freddie raised the prospect that the cycle of markdowns also might be close to an end. Details of the takeover plan are still to be worked out, but in general it means the federal government will now ensure the companies have the capital to continue funding mortgages and -- as important to the markets -- will guarantee repayment of the bonds and other forms of debt issued by them.

The cost to taxpayers is not known, Paulson said. The U.S. Treasury might even make money by directly buying mortgage-backed securities, a step taken to ensure the market continues functioning for that and other types of debt that help keep the mortgage markets fueled with cash, he said.

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