Bailout of Fannie and Freddie fails to calm nerves

From the Financial Times, London
Monday, July 14, 2008

http://www.ft.com/cms/s/0/6a662e74-51cf-11dd-a97c-000077b07658.html

Confidence in some of the largest regional US banks buckled on Monday as the government's rescue plan for mortgage giants Fannie Mae and Freddie Mac failed to allay equity markets' fears over the stability of the broader financial sector.

Stocks in banks including Washington Mutual, the seventh-largest US bank by assets, and Cleveland's National City, plunged as investors reacted to Friday's collapse of IndyMac, a smaller lender.

The sell-off dragged down the stock market and took the shine off the government backing of Fannie and Freddie.

The US Treasury's plan to bolster the two mortgage giants with extra liquidity and the pledge to buy a stake if needed, announced on Sunday, helped to steady the nerves of bond investors who queued up to buy Freddie debt.

But equity investors remained unsettled amid concerns that the two companies, which guarantee $5,300 billion in mortgages -- almost half the US home loans market -- were still vulnerable. Fannie and Freddie shares saw early gains wiped out and ended 7.6 per cent and 8.4 per cent lower, respectively.

The rout in regional banks sent the Standard & Poor’s 500 banks index to its worst daily decline since it was created in 1989. Analysts said the failure of IndyMac, the California lender taken over by the Federal Deposit Insurance Corp., weighed heavily on investors' minds.

Alan Ruskin, chief international strategist at RBS Greenwich said: "The weekend convinced the market of something we all really knew: that [Fannie and Freddie] debt was safe, while IndyMac did the reverse for smaller financial institutions, by highlighting the risk of mass consolidation among those institutions who are not too big to fail."

WaMu, in which a consortium led by the private equity group TPG recently bought a $7 billion stake at around $8.75 per share, fell 35 per cent to $3.23. Investors signalled their fears by driving the cost of one year of credit insurance on WaMu to 13 percentage points over Libor, compared with 8 points for five years of protection.

The cost of credit protection for Wall Street banks such as Lehman Brothers and Merrill Lynch also increased, but at a less dramatic rate than for deposit-taking institutions, suggesting growing fears about Main Street banks. After the market close, WaMu issued a statement saying it was "well capitalised."

Shares in National City plunged 28 per cent to $3.20, their lowest point in more than 20 years, even though the bank said it retained ample regulatory capital and had seen no unusual depositor or creditor activity. "The reality is that a bank can fail and IndyMac will not be the last one," said Kevin Fitzsimmons, analyst at Sandler O'Neill.

However, bond market reactions suggested the rescue plan for Fannie and Freddie had succeeded in its immediate objective, which a senior official characterised late on Sunday night as an attempt to "stabilise the current situation."

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Reporting by Francesco Guerrera, Saskia Scholtes, Henny Sender, and Michael Mackenzie in New York and James Politi and Krishna Guha in Washington.

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