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Fannie, Freddie Feed Fall: The Fed Announces ‘Rescue’

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RISMEDIA, July 15, 2008-Friday’s volatility on Wall Street could signal an even wilder couple of weeks ahead, as the nation’s troubled banks report financial results under a cloud of worry about the future of giant mortgage lenders Fannie Mae and Freddie Mac.

Stocks fell sharply at the open, then climbed just as sharply in the final hour, only to retreat at the finish, leaving financial-services shares at a nearly six-year low.

The roller-coaster prices came amid speculation about a potential federal takeover of the government-chartered companies, which own or guarantee nearly half the nation’s mortgages.

Trouble at Fannie and Freddie could make life even more difficult on Main Street, where credit has become harder to obtain and more costly. Today’s tougher lending standards could give way to virtual paralysis if those key mortgage market-makers go into retreat, some warn.

“The banks are all seized up,” said Patrick Arbor, a former chairman of the Chicago Board of Trade and longtime bank director. “It’s very, very grim.”

A bailout by lawmakers and political appointees, on the other hand, could send the wrong signal about the consequences of risky lending. “They’re choosing who the winners and losers are going to be,” said Brian Battle, vice president of Performance Trust Capital Partners, an investment advisory firm in Chicago. “That’s where it’s getting dangerous.”

Still, Battle believes a takeover of Fannie and Freddie is months away if it happens at all. “There’s no fire right now,” he said.

The Board of Governors of the Federal Reserve System announced Sunday that it has granted the Federal Reserve Bank of New York the authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary. Any lending would be at the primary credit rate and collateralized by U.S. government and federal agency securities. This authorization is intended to supplement the Treasury’s existing lending authority and to help ensure the ability of Fannie Mae and Freddie Mac to promote the availability of home mortgage credit during a period of stress in financial markets.

Whatever happens next will occur with the backdrop of second-quarter results in the financial-services sector. Bellwethers such as Wells Fargo and Merrill Lynch start reporting next week, and analysts expect many of them to cut their shareholder dividends and reduce the stated value of assets on their balance sheets. “If they’re smart, they’ll write down bad loans and take the hits,” said Arbor. “I hate to say it, but I suspect we’re going to have bank failures. I don’t think it’s going to be widespread, though.”

Indeed, late Friday afternoon the assets of California’s IndyMac Bank were seized by federal regulators

Others believe, however, that beaten-down stock prices already take into account the latest troubles. “To a large extent, the disappointments have been discounted in the market,” said Chicago investment manager William Hummer. “The gloom has been excessive. Most of the bad news is out.”

It seemed that way Friday afternoon, when in the final hour of trading the market briefly erased its losses, sending the benchmark S&P 500 into the black for a mere two minutes on word the Federal Reserve would expand its lending to Fannie and Freddie.

As trading ended, the S&P 500 had lost 13.90, or 1.1%, to 1239.49, its lowest level in two years. The Dow Jones industrial average fell 128.48, or 1.1%, to 11,100.54, after earlier tumbling as much as 251 points. The Nasdaq composite index slipped 18.77, or 0.8%, to 2239.08.

Hummer, for one, believes the weekend will bring time for reflection that was missing throughout Friday’s wild session. “Fear took over. It was a terribly unstable day, full of unjustified fear,” he said. “The weekend came just in time. By Monday, we’ll have a calmer opening.”

The weekend could bring clarity from Washington. As of Friday, the government was considering giving Fannie and Freddie access to the Fed’s emergency lending program as one option to prop up the firms, according to Sen. Christopher Dodd ( D-Conn.), who cited conversations with Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson.

Both companies issued statements late Friday calling their financial positions solid. Freddie Mac said it did not see an immediate need to raise fresh money, and said other options included cutting its annual dividend, which costs $650 million a year. Investors drove Fannie and Freddie shares to 17-year lows before the stocks recovered somewhat. Fannie Mae’s shares closed down 22%, at $10.25. Freddie Mac stock fell 3%, to $7.75.

The government created Fannie and Freddie to give more Americans the financing they need to own a home. Under a government takeover, operations would continue, but shareholders would probably see their investments erased.

Short of a takeover, the Fed could provide emergency loans or take on either company’s mortgage-backed securities in an effort to reassure the market. Paulson said Friday that plans call for supporting the pair “in their current form” without a takeover.

Tribune wire services contributed to this report.

Copyright © 2008, Chicago Tribune
Distributed by McClatchy-Tribune Information Services.

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