US Treasury saves Freddie and Fannie

The bailout could hasten the recent retreat from the region's stock markets, even as it proves a boon to Gulf bond holdings.

Treasury Secretary Henry Paulson, Jr. speaks during a news conference in Washington, Sunday, Sept. 7, 2008 on the bailout of mortgage giants Fannie Mae and Freddie Mac. (AP Photo/Susan Walsh) *** Local Caption ***  DCSW107_Mortgage_Giants_Crisis.jpg
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ABU DHABI // The US government's plans to rescue America's two mortgage giants could hasten the recent retreat from the region's stock markets, even as it proves a boon to Gulf bond holdings and a balm to the world's biggest economy. The Treasury Department announced today that it would take control of Fannie Mae and Freddie Mac to prevent financial troubles at the two companies from causing further harm to the beleaguered US housing market. Fannie and Freddie own or guarantee half of America's mortgage debt and are crucial to keeping home loans flowing.

"It is necessary to take action," the US Treasury secretary Henry Paulson said at a news conference announcing the plan. After a four-week investigation of the companies' books that revealed a weak capital base, he said: "I concluded that it would not have been in the best interest of taxpayers simply to make an equity investment in these enterprises in their current form." Economists and bankers said the bailout of Fannie and Freddie was likely to have a three-fold impact on the Gulf and other emerging markets.

While the bailout is undoubtedly good news to Gulf governments that hold an estimated US$25 billion (Dh91.8bn) in the two companies' bonds, it could send the dollar lower, pressuring the relative value of dollar-denominated assets owned by Gulf central banks and sovereign wealth funds. The bailout could also raise the relative allure of bonds, hastening a shift out of emerging markets as a global economic slowdown takes the steam out of the commodities boom.

More broadly, though, economists say the Gulf and other emerging stock markets stand to gain by anything that helps to hasten a recovery by the US economy. "If they fail, it would be a disaster for the US economy," said Aidha al Beraiki, a researcher at Abu Dhabi's Department of Planning and Economy. "In a way they are too big to fail." Selling by foreign investors, particularly hedge funds, has battered regional stock markets in recent weeks. Property stocks have been especially hard hit as investigations in Dubai of fraud allegations rattle a market already concerned that a raft of new supply, combined with a global slowdown, could hurt property prices.

Foreign investors were net sellers of DH336 million worth of stocks on the Dubai Financial Market last week, data show. Foreign investors have sold at least Dh1.84bn worth of stock in Dubai in the past month. The sell-off continued today as reports of the imminent bailout of Fannie and Freddie spread. Saudi Arabia's benchmark index fell 1.7 per cent, while Abu Dhabi's leading index dropped 3.7 per cent, its lowest since November. The benchmark Dubai Financial Market General Index slid 4.6 per cent, an 11-month low. Dubai stocks have lost nearly 25 per cent of their value so far this year.

Concerns about the health of the Federal National Mortgage Association, better known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac, have roiled US financial markets since July. Fannie Mae was set up by the US government in 1938 to help Americans finance their homes, and privatised in 1968. To give it some competition, the US congress created Freddie Mac in 1970. Neither of the two government-sponsored enterprises lends money to homeowners directly. Instead, they buy mortgages from banks, packaging them into securities that are then sold for a fee to investors. By selling their loans for cash, banks reduce their exposure to any one homeowner and can so turn around and lend even more, thereby providing more money at lower interest rates. Falling housing prices and a growing number of defaults have resulted in roughly $14bn in combined losses at the two companies in the past year.

"The housing correction poses the biggest risk to our economy," Mr Paulson said. "Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance." The Treasury's takeover will not involve an immediate injection of cash, but instead place Fannie and Freddie in a conservatorship under the Federal Housing Finance Agency (FHFA) and replace both firms' chief executives. Capital will then be injected over time, as they buy mortgage-backed securities, or MBSs. Some reports said the bailout could eventually cost US taxpayers as much as $25bn.

While a takeover of the two companies will drastically reduce the value of their stock, it will buttress the value of their bonds. Gulf nations have been selling in recent months even as other big Asian governments buy the bonds. According to data from the Treasury Department, Gulf investors sold $1.3bn in agency debt in May and another $480m worth in June. They were net buyers, on the other hand, of US Treasury bonds.

While Fannie and Freddie's debts and guarantees were never explicitly backed by the US government, investors have long assumed that Washington would not let them default. This has allowed the two companies to borrow at rates only slightly higher than the US government. "Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free," Mr Paulson said today.

Gulf executives and bankers said investors in the region had been looking for ways to lower their exposure to dollar-denominated investments amid concerns that the US economic situation was worsening. At the same time, international investors who rushed funds into Gulf markets as oil and other commodity prices were soaring with inflation are now pulling out. With signs growing that global inflation was decelerating and the dollar rebounding as the global economy slowed, many were shifting out of relatively risky emerging market stocks in favour of the relative safety of government bonds. While rising inflation made bonds unattractive, slower inflation and slowing economic growth argued for fixed-income investments, analysts said.

Economists said the Gulf and other emerging markets had more to gain from any measure to right the listing US economy than any impact a decline by the dollar might have.