Fannie Mae, Freddie Mac Turmoil Pose New Economic `Headwind'

By Matthew Benjamin and Craig Torres

July 12 (Bloomberg) -- The slides in Fannie Mae and Freddie Mac, the largest providers of U.S. mortgage financing, threaten to deepen the economic slowdown by curbing credit to a housing industry already in its worst recession in 25 years.

The two companies' shares reached the lowest level in more than 17 years yesterday, making it tougher for them to raise capital at a time when they account for about 80 percent of mortgages packaged into bonds. A failure of the companies would likely send home loan rates higher, causing further declines in home sales and prices.

The dangers mean the Bush administration, which yesterday indicated a government takeover isn't needed, must be ready to keep the companies afloat, investors said. Lawmakers aim to take up a housing bill next week to help buttress confidence in Fannie Mae and Freddie Mac.

``There is no way the [=^]federal[^=] government is going to let either of those agencies die,'' said Eric Hovde, chief executive officer of Hovde Capital Advisors LLC, which runs a $1 billion hedge fund. ``You can't take housing, which is the most important asset class in the country, and mortgages, which are the largest debt markets, and destroy them.''

Fannie Mae and Freddie Mac own or guarantee about half the $12 trillion in U.S. home loans outstanding. Even if the government steps in with some type of rescue, mortgage rates may rise as much as half a percentage point as the cost of selling mortgage-backed securities rises, said Keith Gumbinger, vice president of mortgage research firm HSH Associates in Pompton Plains, New Jersey.

`Headwind for the Economy'

``No matter how this turns out, you have to think'' the mortgage market ``is going to be under more strain,'' said Brian Sack, a senior economist at Macroeconomic Advisers LLC in Washington who used to work at the Federal Reserve. ``That is a headwind for the economy, and something the Fed will have to take into account'' in considering when to raise interest rates.

Fed Chairman Ben S. Bernanke will deliver updated quarterly forecasts when he gives his semiannual testimony on the economy to Congress next week. Traders anticipate the central bank will raise rates this year to head off an acceleration in inflation spurred by oil and food costs.

The Fed, which opened lending to investment banks in March in the first extension of credit to nonbanks since the 1930s, is looking at options for Fannie Mae and Freddie Mac along with other agencies.

`Range of Options'

Spokeswoman Michelle Smith said in an interview she was ``not prepared to discuss the range of options and alternatives being considered.'' The Fed hasn't spoken with the two firms about access to direct loans, she said.

Treasury Secretary Henry Paulson said in a statement yesterday that ``our primary focus is supporting Fannie Mae and Freddie Mac in their current form.'' The government-sponsored enterprises have [=^]federal[^=] charters and are shareholder-owned companies.

Shares of the two companies closed lower, with Fannie Mae losing $2.95 to $10.25 and Freddie Mac down $0.25 at $7.75 in New York Stock Exchange composite trading. Washington-based Fannie Mae's market capitalization has fallen to $10.1 billion from $38.9 billion in December, according to Bloomberg data. McLean, Virginia-based Freddie Mac's total has slumped to $5 billion, from $22 billion over the same period.

``The substantially smaller market values could dramatically hinder the companies' ability to raise additional capital,'' CreditSights Inc. analysts Richard Hofmann and Adam Steer wrote in a note to investors Friday.

House Prices Fall

The declining availability of credit pushed down home values in 20 U.S. metropolitan areas during April at a record rate, according to the S&P/Case Schiller home-price index. The index dropped 15.3 percent from a year earlier.

Senate lawmakers yesterday approved a bill including $300 billion to help thousands of Americans keep their homes and tighter regulation of Fannie Mae and Freddie Mac. The House previously approved its own version, and legislators may reach agreement on a final bill to send to President George W. Bush for signature next week, Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said yesterday.

Economists already anticipate economic growth will dwindle to a 0.6 percent pace by the final three months of 2008, the weakest pace in six years, according to the median estimate in a monthly Bloomberg News survey. Declines in residential construction have subtracted from gross domestic product for nine straight quarters through March.

Rising Role

As mortgage providers retreated from signing new loans, the housing market has relied on Fannie Mae and Freddie Mac to step up. The two firms accounted for 81 percent of the home loans that were packaged into securities in the first quarter, according to the Office of [=^]Federal[^=] Housing Enterprise Oversight.

``This rapid growth pace'' in firm's portfolios ``will probably need to continue if we want to avoid an even sharper deterioration in overall credit availability than is already occurring,'' said Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York. Deteriorating credit creation is the ``key vulnerability'' for the U.S. economy, he said.

To contact the reporters on this story: Matthew Benjamin at mbenjamin2@bloomberg.net

Last Updated: July 12, 2008 00:01 EDT

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U.S. Stocks Bear Market Deepens With Sixth Straight Weekly Drop

By Elizabeth Stanton

July 12 (Bloomberg) -- U.S. stocks fell for a sixth week, sending the Standard & Poor's 500 Index into a bear market, as fuel prices climbed to records and investors speculated Fannie Mae and Freddie Mac won't survive the mortgage crisis.

Fannie Mae and Freddie Mac, the government-chartered companies that are the largest source of financing for U.S. home mortgages, tumbled to 17-year lows. They led the S&P 500 to a 20 percent drop from its Oct. 9 record, marking a bear market for the benchmark equity gauge. The Dow Jones Industrial Average entered a bear market a week earlier.

The S&P 500 fell 1.9 percent to 1,239.49, the lowest since July 2006, completing the longest streak of weekly declines since July 2004. The Dow average fell 1.7 percent to 11,100.54 for its fourth weekly drop. The MSCI World Index of 23 developed markets fell 1.1 percent to 1345.47, entering a bear market.

``I would love to be bullish, but I think that's a little premature,'' said Julie Van Cleave, who manages $4 billion as head of large U.S. growth stocks at Deutsche Asset Management in Milwaukee. ``We're going from a period of credit expansion to a period of credit contraction.''

The declines left the S&P 500 and the Dow down 16 percent for the year as earnings season enters its second week. Eight of the 30 companies in the Dow average and 62 S&P 500 companies are scheduled to report results next week, beginning with Intel Corp. and Johnson & Johnson on Tuesday.

Declining Profits

S&P 500 profits are forecast to decrease 13.6 percent from a year ago, led by a 69 percent drop in financial earnings, according to analysts surveyed by Bloomberg. A fourth consecutive quarterly decline would be the longest streak since the last recession in 2001.

The cost of using options as insurance against losses in the S&P 500 rose to a three-month high. The VIX, as the Chicago Board Options Exchange Volatility Index is known, climbed 11 percent to 27.49.

Financial shares led the S&P 500 lower, falling 6.3 percent to a nine-year low.

Fannie Mae fell 45 percent to $10.25 and Freddie Mac tumbled 27 percent to $7.75. Fannie Mae pared a decline of as much as 49 percent and Freddie Mac rebounded from a 51 percent drop after U.S. Treasury Secretary Henry Paulson signaled that a government takeover of the companies won't be necessary.

Lehman Brothers Holdings Inc., once the biggest underwriter of U.S. mortgage bonds, fell 37 percent to the lowest level since 1999.

Crude oil, little changed on the week, touched a record $147.27 a barrel yesterday. Gasoline futures reached an all-time high of $3.631 a gallon, and pump prices rose to $4.108 a gallon on July 7.

Discretionary Spending

Companies that depend on discretionary spending by consumers fell 4.1 percent to a five-year low, led by Office Depot Inc. The world's second-largest retailer of office supplies tumbled 37 percent to $6.84, its biggest drop in 11 years, after saying its second-quarter report on July 30 will show earnings deteriorated more than it previously forecast.

J.C. Penney Co. fell 16 percent to $30.75, the lowest since February 2004. The department-store chain said June sales at stores open at least a year dropped 2.4 percent.

Retail sales probably rose less in June than in July, a July 15 Commerce Department report is projected to show. Sales probably increased 0.4 percent, according to the median forecast of economists polled by Bloomberg. Excluding automobiles, they probably rose 1 percent.

`Cannot Continue'

Continental Airlines Inc. led airlines to the lowest in the 15-year history of the Amex Airline Index. James May, president of the Air Transport Association, the industry's trade group, said airlines ``cannot continue to survive at $140 oil.'' Continental, the fourth-largest U.S. carrier, fell 20 percent to $7.28, a five-year low.

Intercontinental Exchange Inc., owner of Europe's largest energy market, declined 17 percent to $88.40. Senator Joseph Lieberman yesterday proposed legislation to curb speculation in food and energy futures.

Congress ``is convinced that ICE is helping speculators manipulate the price of oil,'' said Michael Allocco, chief investment officer at Brazos Capital Management LP in Dallas, who sold his remaining shares of the company on July 10. Investors are concerned the exchange ``may bear the brunt of any ill-conceived legislation.''

Mergers or merger prospects boosted shares of target companies including Rohm & Haas Co., Hercules Inc. and Yahoo! Inc., limiting the market's decline.

Takeovers

Rohm & Haas rose 66 percent to $74.70 after the maker of paint ingredients and adhesives agreed to an $18.8 billion takeover by Dow Chemical Co. Hercules Inc. gained 30 percent to $20.95. The maker of papermaking chemicals will be acquired by Ashland Inc. for $3.3 billion.

Yahoo climbed 10 percent to $23.57. Microsoft Corp. said it may revive takeover talks for the second most popular U.S. Web search engine if investors back Carl Icahn's attempt to replace Yahoo's board and chief executive.

The Russell 2000 Index, a benchmark for companies with a median market value 23 times smaller than the S&P 500, rose 1.4 percent to 674.95.

Yields on Treasury securities declined as traders pared bets the Federal Reserve will raise interest rates before October. The 10-year note's yield declined to 3.89 percent from 3.98 percent.

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net

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Bernanke Says Fed May Continue Lending Into Next Year

July 8 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke, seeking to allay renewed concerns over the health of the nation's financial system, said the central bank may extend its emergency-loan program for investment banks into next year.

``The Federal Reserve is strongly committed'' to financial stability and is ``considering several options, including extending the duration of our facilities for primary dealers beyond year-end,'' Bernanke said in a speech to a conference in Arlington, Virginia.

The Fed chairman's comments, the first time he has indicated how long he'll extend the lending programs, come a day after an index of bank shares reached its lowest level since 1996.

Bernanke also endorsed proposals to set up a federal liquidation process for a failing investment bank. The Treasury should ``take a leading role in any such process'' in consultation with regulators, he said. Such a resolution mechanism may help reduce concern that investors and dealers begin counting on Fed aid in case their bets go wrong.

The Fed started the unprecedented lending programs for investment banks in March under its authority to lend to nonbanks in ``unusual and exigent circumstances.'' Officials said at the time the Primary Dealer Credit Facility, which provides direct loans, would last for ``at least'' six months.

Rate Outlook

Continued lending to investment banks may make it harder for the Fed to raise interest rates this year. Traders estimate 74 percent odds of at least quarter point increase in the 2 percent benchmark rate by year-end.

``There was some speculation that, come September,'' the lending programs ``might be allowed to expire,'' Dominic Konstam, head of interest-rate strategy at Credit Suisse Securities USA LLC in New York, said in a Bloomberg Radio interview. ``A lot of people would have thought that might be a prelude to the Fed beginning a tightening cycle. Now, that is obviously that much more uncertain.''

The Standard & Poor's 500 Banks Index, a measure of 22 firms including Fannie Mae and Freddie Mac, the largest sources of U.S. home financing, fell to 155.48 yesterday, its lowest level since 1996.

The Fed chairman didn't comment on the outlook for the economy or monetary policy in his remarks today to a Federal Deposit Insurance Corp. forum on mortgage lending. Treasury Secretary Henry Paulson and JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon are also scheduled to speak at the event.

The PDCF and the Fed's Term Securities Lending Facility, which auctions as much as $200 billion in Treasuries are both aimed at the 20 primary dealers in U.S. government debt.

Capital `Buffers'

The Fed is working with the Securities and Exchange Commission and securities dealers ``to increase the firms' capital and liquidity buffers,'' Bernanke said.

Securities firms have cut back on their use of the programs in recent weeks. The balance of loans outstanding from the PDCF dropped to zero as of July 2, the first time that's happened since the program began. On March 26, the end of the first full week of operation, the PDCF had a balance of $37 billion.

Bids in the TSLF's weekly auctions, in which dealers swap securities such as mortgage-backed debt for Treasuries from the New York Fed, have declined since the start of the program. In the July 3 operation, firms submitted bids for $26.1 billion out of $50 billion of Treasuries offered.

Financial Strains

One gauge of financial stress watched by the Fed has remained elevated. The difference between the overnight indexed swap rate, a measure of what traders expect for the Fed's benchmark rate, and three-month interbank loans in dollars was 0.78 percentage point yesterday, about the same as the start of May.

``Although short-term funding markets remain strained, they have improved somewhat since March,'' Bernanke said.

Bernanke's comments on the resolution authority are in line with Treasury Secretary Henry Paulson's July 2 statement that ``any commitment of government support should be an extraordinary event that requires the engagement of the executive branch.''

FDIC Chairman Sheila Bair has also said an agency should be given such liquidation authority for investment banks. The FDIC has that power over lenders whose deposits it insures. In the case of commercial banks, the use of taxpayer funds in an emergency requires the approval of two-thirds majorities of the FDIC and Fed boards, and of the Treasury secretary in consultation with the president.

`Worth the Effort'

``Despite the complexities of designing a resolution regime for securities firms, I believe it is worth the effort,'' Bernanke said today. ``In particular, by setting a high bar for such actions, the adverse effects on market discipline could be minimized.''

Bernanke endorsed several ways for the Fed and other U.S. agencies to gain more oversight of investment banks and financial markets. Congress should legislate ``consolidated supervision'' of investment banks and other big securities firms, with the unspecified regulator having authority over capital, liquidity holdings and risk management, he said.

The Fed itself should also get ``explicit oversight authority'' over payment and settlement systems, putting the Fed on par with counterparts from around the world, Bernanke said.

Congress may consider giving the Fed responsibility for ``promoting the overall stability of financial markets,'' Bernanke said. Still, ``it would be particularly important to make clear that any government intervention to avoid the disorderly liquidation of firms on the verge of bankruptcy should use clearly defined tools and processes,'' he said.

The Fed will play a part in setting capital cushions at securities firms under an agreement yesterday with the SEC designed to dispel concern a failing financial company without central bank oversight could threaten the economy.

The Fed and SEC will collaborate in determining ``guidelines or rules concerning the capital, liquidity and funding'' arrangements of investment banks, the accord said. They will also cooperate in designing ``risk management systems and controls'' for securities firms.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: July 8, 2008 10:35 EDT

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G8: Oil prices pose risk to world economy

TOYAKO, Japan (CNN) -- Leaders of the Group of Eight nations expressed long-term optimism Tuesday about their economies. They also expressed concern over high commodity prices, including the prices of food and oil.

"Elevated commodity prices ... pose a serious challenge to stable growth worldwide," the leaders said in a statement on the second day of their three-day summit.

"We have strong concerns about the sharp rise in oil prices, which poses risks to the global economy."

The leaders called for an increase in oil production and refining, but also said it was important to "improve energy efficiency as well as pursue energy diversification."

They challenged oil-producing nations to boost production capacity to meet rising global demand.

First Published: July 8, 2008: 4:31 AM EDT


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Stocks Fall in Europe, Asia on Loss Concern; U.S. Futures Drop

By Sarah Jones

July 8 (Bloomberg) -- Stocks fell in Europe and Asia and U.S. index futures dropped as concern deepened financial firms will need more capital and lower oil weighed on energy producers. The U.K.'s FTSE 100 Index entered a bear market.

UBS AG and Deutsche Bank AG slumped in Europe and Mitsubishi UFJ Financial Group Inc. led a retreat by Asian banks after analysts said the two largest U.S. mortgage-finance companies may have to raise a combined $75 billion. Merrill Lynch & Co. fell in Germany after Wachovia Corp. slashed its earnings forecast for the securities firm. Royal Dutch Shell Plc dropped after oil decreased almost $4 a barrel yesterday.

The MSCI World Index lost 0.9 percent to 1,352.86 at 9:13 a.m. in London, extending its decline from an October record to 19.6 percent. Futures on the Standard & Poor's 500 Index fell 1 percent, indicating the benchmark index may slip into a bear market today. The S&P 500 was down 19.99 percent from an all- time high in October as of yesterday's close.

``Investors are nervous,'' said Chicuong Dang, an analyst at Richelieu Finance in Paris, which has $6.2 billion under management. ``The market is falling on fears of bad news from banks, of new writedowns and need for recapitalization.''

Financial stocks from Citigroup Inc. to HBOS Plc have led declines that erased more than $11 trillion from equity markets worldwide this year as credit-related losses topped $400 billion, forcing banks to raise more than $320 billion in capital and threatening to push the U.S. into recession.

``In a recession, earnings always fall,'' said Joost van Leenders, Amsterdam-based investment specialist for asset allocation at Fortis Investments, which oversees $342 billion. ``There is more to come in earnings and the stock market than is currently foreseen.''

Earnings Kickoff

Profit for Stoxx 600 companies will fall 2 percent this year, according to data compiled by Bloomberg. That's down from 11 percent growth predicted at the start of 2008.

Alcoa Inc., the world's third-largest aluminum company, kicks off the second-quarter reporting season in the U.S. today. Analysts estimate earnings at companies in the S&P 500 dropped 11 percent on average in the quarter, Bloomberg data show.

Europe's Dow Jones Stoxx 600 Index declined 2.5 percent, while the MSCI Asia Pacific Index lost 2 percent. The U.K.'s FTSE 100 dropped 2.3 percent, extending its decline from last year's high to 20 percent, the common definition of a bear market.

Sales of services and manufactured in the U.K. fell in the second quarter, posing ``serious risks'' that the economy will tumble into a recession, the British Chambers of Commerce said.

UBS, Mitsubishi UFJ

UBS, the European bank hardest hit by the subprime contagion, sank 4.1 percent to 19.16 francs. Deutsche Bank, Germany's largest bank, slipped 3.6 percent to 52.62 euros.

Analysts at Lehman Brothers Holdings Inc. said a change in accounting rules may force Fannie Mae and Freddie Mac to raise $46 billion and $29 billion respectively.

Mitsubishi UFJ, Japan's largest bank by market value, declined 3.4 percent to 934 yen.

Kookmin Bank, South Korea's largest, tumbled 8.6 percent to 55,000 won. JPMorgan Chase & Co. cut its recommendation on the stock to ``neutral'' from ``overweight,'' saying Kookmin may not have enough capital to complete its plan to set up a holding company.

Merrill Lynch lost 84 cents to $29.52 in Germany. Wachovia lowered its second-quarter earnings-per-share estimate for the third-largest U.S. securities firm to a loss of $2.16 from a profit of 63 cents and dropped its forecast for 2008 to a loss of $3.11 from a profit of 15 cents.

Analysts forecast $5 billion in writedowns for the quarter concerns and said the sale of stakes in BlackRock Inc. and Bloomberg LP, the parent of Bloomberg News, by Merrill would be ``negative.''

Bank of Ireland

Bank of Ireland Plc tumbled 8.7 percent to 4.62 euros after the Dublin-based lender said slowing economic growth in Ireland and the global shortage of credit are ``adversely impacting'' earnings.

``The slowdown in the overall level of activity and volume growth is most pronounced in our retail businesses in Ireland,'' the bank said.

Separately, the Daily Telegraph reported Bank of Ireland is reducing its commercial lending, telling some U.K. customers it won't be taking new business for the next three months.

Shell, Europe's biggest oil company, slid 2.9 percent to 1,982 pence. BP Plc, the second-largest, retreated 2.5 percent to 558 pence.

Crude for August delivery lost $3.92, or 2.7 percent, to $141.37 yesterday. Oil traded at $142.27 today.

Persimmon Plc lost 4.7 percent to 217.25 pence after the U.K.'s second-biggest homebuilder by market value said first- half sales fell 34 percent and it has cut 1,100 jobs to lower costs amid the worst British housing slump in 30 years.

Great Portland

Great Portland Estates Plc fell 2.1 percent to 316.75 pence after Morgan Stanley rated the company, which develops shops and offices in London's West End, ``underweight'' in new coverage on the possibility that rents in the U.K. capital's center will fall.

Klepierre SA declined 5.8 percent to 29.58 euros after Credit Suisse Group downgraded the European shopping center owner to ``underperform'' from ``neutral.''

Fiat SpA dropped 4.4 percent to 9.87 euros. Italy's biggest manufacturer said it will close four of its six car factories for one week each between September and November because of slumping sales.

To contact the reporter on this story: Sarah Jones in London at sjones35@bloomberg.net.

Last Updated: July 8, 2008 04:23 EDT

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