By Adam Shell, USA TODAY
Wall Street staged its biggest rally in a month Monday as stock investors bet that the government's move to seize and backstop the USA's two largest mortgage finance companies will help stabilize the housing market, thaw credit markets and boost the ailing economy.
The Dow Jones industrial average jumped 289.78 points, or 2.6%, to 11,510.74. But common shares of Fannie and Freddie were essentially wiped out, since common-stock shareholders are last in line in any claims.
The jubilant response to the historic federal takeover of Fannie Mae and Freddie Mac was driven by a belief among investors that a financial panic can be averted. Investors had feared that home buyers wouldn't be able to get credit if the two institutions folded.
Still, investment pros caution that the intervention won't cure the crisis in the housing and mortgage markets or lead to any immediate economic recovery.
"It takes one of the major issues off the table: the uncertainty of what would happen if these two entities failed" under the weight of a tsunami of unpaid mortgages, says Chuck Carlson, a portfolio manager and contributing editor of Dow Theory Forecasts.
Michelle Clayman, chief investment officer at New Amsterdam Partners, says the rescue "calmed fears" and sent a message to investors, homeowners and potential home buyers that cash to fund real estate purchases and transactions would not dry up.
But, she adds, "There's still some worrying data out there. Home inventories remain high. Foreclosure data is high, with 9% of all mortgages delinquent. That's huge. And you will continue to see financial institutions in distress. Is this an all-clear signal? Not necessarily."
The housing market has been suffering from falling prices, a record spike in foreclosures and a weak economy. The government's plan to inject up to $100 billion in each of the two government-sponsored entities has already helped lower mortgage rates, reducing costs for borrowers.
It's anyone's guess whether Monday's gains in the stock market will stick. Stocks rallied furiously on two other recent occasions when the government stepped in to avert a meltdown in the current financial crisis: In mid-March, when it orchestrated JPMorgan's purchase of Bear Stearns, and in mid-July, when it first announced plans to prop up Fannie and Freddie if necessary.
Both rallies stalled, and stocks fell to their prior levels within a week. Scott Black, president of Delphi Management, says this rally may also be fleeting. One big problem, Black says, is that there's no quick cure to the oversupply of homes for sale.
The government's decision to take over the two publicly traded companies generated some skepticism in Washington. Senate Banking Committee Chairman Chris Dodd, D-Conn., said he wasn't necessarily opposed to the move but needed to know a lot more detail and plans to hold a hearing later this week.
Peter Schiff, president of Euro Pacific Capital, argued that the government's intervention will actually prolong the housing downturn. The plan, he says, is designed to keep home prices from falling. And that means prices will remain artificially high, setting up the government-controlled lenders for a wave of fresh foreclosures in the future.
"It will make the problem bigger," Schiff says.
Others agree that beyond Monday's celebratory bounce on Wall Street, it's far from clear that the government's move will solve other problems related to the housing crisis.
Here's a look at some possible consequences:
Mortgage rates
Average rates on 30-year fixed-rate mortgages, which have hovered well above 6% for months, plunged from 6.5% Friday to near 6% Monday, says Bankrate.com, according to national overnight averages. And most analysts expect the government's takeover of Fannie and Freddie to extend that decline, at least in the short term.
In part, that's because in taking control of the two companies, the U.S. Treasury will buy mortgage-backed securities, thereby driving their prices up and mortgage yields down. The takeover should also shore up confidence in Fannie and Freddie and the mortgages they own or guarantee.
"Early indications are that mortgage rates are dropping about half of a percentage point," says Greg McBride, senior financial analyst at Bankrate.com. "It remains to be seen if this will hold, because investors are bound to be concerned about how much debt Uncle Sam is taking on."
As of Friday, mortgage rates were a full percentage point higher than they would be expected to be based on the benchmark 10-year Treasury yield, he says, noting that the spread between the two rates was the widest it had been in 22 years.
"That spread will improve as a result of the takeover by the government," McBride says. "But the spread will not immediately go back to the historical average, because there is still a lot of uncertainty about the quality of outstanding mortgages."
With Fannie Mae and Freddie Mac having placed their primary focus on merely surviving, McBride says, they were buying fewer loans and charging higher fees on the loans they did buy, resulting in higher rates for borrowers.
"Short term, this is a definite win for borrowers," he says. "The availability of mortgage credit is not in question. Borrowers will see better terms."
Cameron Findlay, LendingTree chief economist, says borrowers will see better rates, but maybe not as attractive as they'd hoped. He cautions that lenders might not pass all the benefits on to borrowers.
