Gov't Expected to Help Fannie, Freddie, But No One Else

July 14, 2008 - 8:22 AM
The U.S. government is signaling it won't throw a lifeline to struggling financial companies -- except for mortgage linchpins Fannie Mae and Freddie Mac.<br style="mso-special-character: line-break" />
(Associated Press) - The U.S. government is signaling it won't throw a lifeline to struggling financial companies -- except for mortgage linchpins Fannie Mae and Freddie Mac -- marking a shift to a new and potentially more volatile phase of the credit crisis.

Such an approach could mean beaten-down investment banks like Lehman Brothers Holdings Inc. and regional banks must now fend for themselves as they try to recover from billions of dollars in mortgage-related losses -- unlike Bear Stearns Cos., whose buyout the government helped orchestrate in March.
 
That is bound to unnerve an already turbulent Wall Street and make investors even more anxious as they await financial companies' earnings expected to be down a stunning 69 percent from a year ago when all the numbers are in.

And, for consumers already squeezed by tightening credit standards, it could mean getting a mortgage will become even harder.

The short-term uncertainty about Freddie Mac and Fannie Mae -- which together hold or guarantee half the nation's mortgage debt -- was relieved on Sunday to some extent. Federal officials again threw their support behind the government-sponsored enterprises; the Treasury pledged to expand its current line of credit to the two companies and Treasury Secretary Henry Paulson also said the government could, if needed, buy equity capital in the companies, whose stocks lost half their value last week. The Treasury's moves would require congressional approval.

Meanwhile, the Federal Reserve said it will provide additional loans if needed.

But some of Wall Street's biggest investors believe there was another message in the government's announcement -- the rest of the financial sector seems unlikely to get a helping hand. Global banks and brokerages have already written down nearly $300 billion in soured mortgage investments -- a number projected to ultimately reach $1 trillion.

"The credit crisis has obviously entered into a new phase -- the government has one bailout left in them, and this is it," said Jeffrey Gundlach, chief investment officer of TCW Group in Los Angeles, which invests $160 billion.

"One consequence of Freddie and Fannie is that other firms are allowed to go under," he said. "If you couldn't get your act together after four months of unprecedented financing terms, maybe you don't deserve to be thrown yet another lifeline."

Worries about financial companies failing intensified after a run on IndyMac Bancorp Inc. led to the bank's takeover by the government on Friday. It wasn't the Treasury or Fed helping to keep IndyMac in business, but a transfer of control to the Federal Deposit Insurance Corp. -- which backs deposits on all the nation's banks.

Analysts said these kind of failures will curtail competition among financial institutions, which might in turn make it even harder for some borrowers to get mortgages, personal or auto loans or credit cards.

On Wall Street, Monday could be a critical day, with investors quite nervous amid the uncertainty in the financial sector. Friday, as investors tried to assess the health of the mortgage financiers, the Dow Jones industrial average dropped below 11,000 for the first time in nearly two years, and the overall market was left with its fourth straight weekly loss. The government's support of Fannie and Freddie in part was meant to assuage investors around the world.

Wall Street will get a better sense of how concerned investors are with Fannie Mae and Freddie Mac's future immediately Monday morning. Freddie Mac is scheduled to hold its weekly debt auction beginning at 8 a.m. EDT. The auction closes at 9:45 a.m., shortly after U.S. markets open.

Successful completion of the debt auctions allows both lenders to remain liquid -- replacing old debt with new. Liquidity has been one of the key questions facing financial companies during the credit crisis.

Freddie Mac is auctioning off a combined $3 billion in three- and six-month securities. Wall Street will be looking very closely at the number of bidders and the rate at which the securities are auctioned, said Bert Ely, a banking consultant who has been critical of the companies in the past.

"I'll be surprised if the results aren't strong," he said, noting the government was likely heavily encouraging investors throughout the weekend.

The banking industry was already dealt a severe blow in March when Bear Stearns nearly collapsed amid the evaporation of its liquidity. JPMorgan Chase & Co. stepped in to purchase Bear Stearns in a deal orchestrated by the Federal Reserve.

Bear Stearns was unhinged by mounting losses tied to investments in bonds backed by mortgages. As the mortgages increasingly defaulted, the value of bonds backed by the troubled loans tumbled. After Bear collapsed, investment banks were given the opportunity to borrow directly from the Fed, an option that was previously only granted to retail banks.

Financial companies' reports of write-downs of troubled debt are likely to increase this week as some of the country's largest institutions, including JPMorgan Chase, Merrill Lynch & Co. and Citigroup Inc., report second-quarter results. That trio has already taken a combined $73 billion in write-downs since the credit crisis began last summer.

Lehman Brothers, whose shares have lost 78 percent since this year's peak in February, is considered to be on the shakiest ground because it is the smallest Wall Street bank and has significant mortgage holdings. Last month, the investment bank announced it lost nearly $3 billion during the second quarter and was forced to offset that by raising $6 billion of fresh capital.

Meanwhile, analysts believe regional banks in areas hardest hit by the real estate downturn are also at risk for failure. Some of the most bandied about names include Washington Mutual Inc., National City Corp., and Fifth Third Bancorp.

"Fannie and Freddie are too big to fail only because of the repercussions, not to just the mortgage and housing markets but the entire financial market," said Joe Balestrino, fixed-income market strategist at Federated Investors. "The U.S. is in disarray ... these regionals could be gone, they are in a tough spot with housing and employment going south."