Monday, July 14, 2008

US Economic Crisis Bulletin: Wall Street Falls on Fears Over Financial Failures; IndyMac Credit Lines Frozen; Higher Anxiety Over Mortgages, Banks & Oil, etc.

Wall Street falls on fears over financials

By Jeremy Lemer
Financial Times
Published: July 14 2008 13:59

US stocks initially rose on Monday morning after the US government announced a series of extraordinary measures to shore up confidence in Fannie Mae and Freddie Mac, but then fell back to lower levels.

On Sunday evening, after a weekend of crisis talks, the Treasury said it was seeking congressional authority to increase the line of credit it offers the government-sponsored entities and to purchase equity in them if needed.

In the interim period, Fannie and Freddie will both be given access to the Federal Reserve’s discount window.

The two GSEs, which buy or finance almost half of the $12,000bn US mortgage market and have long been seen to have an implicit guarantee from the US government, have been a constant drag on equity markets in recent days.

Speculation that the pair needed more capital but would be unable to raise it sent their share prices tumbling and raised the spectre of systemic financial collapse yet again.

As if to underline the scale of the problems in the financial sector, on Friday federal banking regulators closed IndyMac Bancorp when it was no longer able to meet continued demands by customers for their deposits – making it the biggest savings bank to fail in US history.

But analysts at Barclays Capital were cautious about the long term impact of the rescue package.

“While we believe that this removal of short-term systemic risk is likely to improve sentiment and support GSE credit and equity in the short term,” they said “in the longer term we believe that GSE capital requirements will likely increase as credit losses are likely to be sizeable.”

In early trade on Monday the reaction to the government moves was tepid. Fannie shares rose 10.3 per cent to $11.31 while Freddie shares added 4.9 per cent to $8.13.

The benchmark S&P 500 was down 0.1 per cent at 1237.71 in early trade. The Dow Jones Industrial Average was flat at 11,098.43 while the Nasdaq Composite 0.5 per cent lower at 2,226.69.

US stock markets ended last week definitively in bear market territory. The S&P 500 posted its sixth straight weekly decline as investors rushed to sell Fannie and Freddie on speculation that a government bail-out could wipe out shareholders while oil prices spiked above $147, pummelling consumer-facing stocks.

With that threat off the table, financial stocks were expected to rally strongly but by mid- morning the financials sector was considerably lower.

Lehman Brothers, the perennial whipping boy of the current round of the credit crisis, found some momentum thanks to the news and a cautiously positive report from Bernstein Research analysts but failed to sustain the rally.

Analysts led by Brad Hintz said: “Bernstein believes that the strengthening of Lehman’s funding base and balance sheet combined with the continued support of the Federal Reserve, means that firm should be able to survive any confidence crisis ahead.”

The stock fell 4 per cent to $13.84.

But the sector as a whole fell back after regional banks came under heavy selling pressure.

Goldman Sachs added Zions Bancorp to its Conviction Sell list and slashed its target price on the stock from $39 to $21.

Meanwhile, M&T Bank said its second-quarter profit fell 25 per cent due to credit losses related to residential real estate.

Zions fell 14.4 per cent to $22, M&T Bank dropped 5.5 per cent to $65.88 while the sector as a whole lost 0.4 per cent in early trade.

Materials stocks were the strongest gainers, adding 1.4 per cent.

Allegheny Technologies surged 11.6 per cent to $56.19 after the specialty metals producer said second-quarter profit would be higher than previously forecast.

Technology stocks also made strong gains as investors cheered news that Apple had sold 1m of its new iPhones in the first three days after the launch.

The news helped offset declines for Yahoo after the search company rejected a break-up bid from Microsoft and activist investor Carl Icahn.

Apple added 2.9 per cent to $177.56 while the sector gained 1 per cent. Yahoo meanwhile slipped 3.4 per cent to $22.78 while Microsoft rose 1.8 per cent to $25.70.

Some deal news also boosted sentiment. InBev said it would buy Anheuser-Busch, the maker of Budweiser beer, for $52bn ending a month of court fights and public bickering.

Anheuser-Busch shares rose 1.9 per cent to $67.75, just below the $70 a share offer level.

Waste Management, the largest US waste disposal company, said it would bid $34 a share to buy Republic Services in a deal valued at $6.19bn.

Waste Management lost 5.8 per cent to $34.50 while Republic jumped 14.1 per cent to $31.82.

A moderation in oil prices also lifted markets and consumer-facing and energy dependent stocks in particular.

Wal-Mart shares bounced 0.5 per cent to $56.57, while Ryder System rose 1.5 per cent to $66.78. The consumer discretionary and staples sectors added 0.8 per cent each.

This week, second quarter earnings season begins to accelerate as 59 S&P 500 companies and eight Dow components are anticipated to announce earnings. According to Thomson Reuters, analysts expect quarterly earnings to decline by 14.7 per cent.

Feds to freeze IndyMac's home-equity credit lines

Los Angeles Times
6:43 PM, July 13, 2008

The Federal Deposit Insurance Corp. today provided more guidance for IndyMac Bank customers who are awaiting the bank’s reopening on Monday, after it was declared insolvent on Friday and seized by the government.

Some key points from a news conference the FDIC held today, as relayed by Times staff writer Kathy M. Kristof:

--Customers with home-equity credit lines will have their accounts frozen and "reviewed on a case-by-case basis," according to the FDIC. That’s a move by the agency to make sure its losses on the bank’s loan portfolio don’t balloon from the FDIC’s current estimates.

--Lines of credit to commercial construction contractors also will be frozen pending a review, but construction loans made to individual consumers won’t be affected.

--Customers of IndyMac’s reverse-mortgage subsidiary will continue to have access to their funds. Reverse mortgages provide elderly homeowners with either regular payments or a line of credit secured by their homes.

--For insured depositors, the bank will continue to honor existing terms on accounts, meaning the interest rates on outstanding certificates of deposit will be whatever IndyMac promised.

But that won’t apply to so-called brokered deposits -- funds brought in by Wall Street firms or other middlemen. Those deposits stopped accruing interest Friday, and once the FDIC identifies all the uninsured depositors the brokered deposits that are within insurance limits will be returned to their owners.

--Depositors with funds over the FDIC’s insurance limits will have access to 50% of the uninsured sum beginning on Monday. Whether they get any more of that money back will depend on how much the FDIC recovers in selling IndyMac assets in the next few months.

High anxiety around oil, mortgages and banks

By Madlen Read, The Associated Press
July 14, 2008

For investors, stocks look like bad karma: Wall Street again starts a week with oil prices at their highest levels yet, and banks poised to reveal that they remain on shaky footing.

None of the troubles that have rocked the market over the last year have let up yet -- not the housing market, not high commodity costs, not the ailing financial system.

"We've got a fistful of drivers that are working against the market," said Arthur Hogan, chief market analyst at Jefferies & Co. "And they're all important."

It's a different collection of worries from those that hurled stocks lower at the beginning of the decade after the technology bubble burst and the Sept. 11, 2001, terrorist attacks sent the country reeling.

But many on Wall Street are worried that the effects of the country's current problems could end up being just as devastating, or more so, for stocks.

The Dow Jones industrial average dropped below 11,000 for the first time in nearly two years before settling at 11,100.54 on Friday. The blue-chip index ended the week down 1.7%; the Standard & Poor's 500 index fell 0.3% and the Nasdaq composite index fell 1.9%.

The three indexes are firmly entrenched in bear market territory, down more than 20% from their peaks last fall. The average bear market ultimately has involved a drop of about 30%, Hogan said.

Because stocks have tumbled recently, it's possible that bargain buyers might reenter the market this week. And if this earnings season follows the same pattern as first quarter reports, second-quarter results that are not quite as bad as the pessimists anticipate could lead to brief relief rallies.

"We're preparing for a worst-case scenario for the financials, for Freddie Mac and Fannie Mae, for the market in general. If we don't get that, we may celebrate a bit," Hogan said. However, "it's a market that's struggling to find anything that's positive to rally on."

On Friday, oil prices soared to a new trading record above $147 a barrel, following a pullback of nearly $10 a barrel Monday and Tuesday. After that massive reversal, Wall Street is likely to take any decline in oil this week with a grain of salt.

The effect of oil and other commodity prices on consumers and businesses will be seen in the Labor Department's consumer and producer price indexes this week.

Investors also will parse the National Assn. of Home Builders' July survey of housing market conditions Wednesday and the Commerce Department's June report on new-home construction.

Meanwhile, Wells Fargo & Co. on Wednesday and JPMorgan Chase & Co. on Thursday are expected to report profit declines. Citigroup Inc., the nation's largest bank by assets, is expected to post its third straight quarterly loss.

Wall Street also will be waiting to see whether the government will take action to rescue Fannie Mae and Freddie Mac. Shares of the two troubled mortgage giants plummeted by 45.4% and 46.6% respectively last week.

Until the housing market starts seeing signs of recovery, it is going to be difficult for the financial sector to see significant improvement in consumer credit conditions, the tight credit markets or the value of mortgage-backed securities. Lehman Bros. Holdings Inc., like Fannie and Freddie, saw its shares plummet last week.

"Without question, everyone's terrified. I really couldn't understand why there would be a rumor about a run on Lehman Bros.," said Thomas J. Lee, a stock analyst at JPMorgan, noting that the Federal Reserve has said investment banks can borrow from the central bank's discount window.

"It sounds like people living in fear and terror," Lee said. "But as I put myself in the shoes of a portfolio manager, I can't imagine them wanting to ride the stock down to zero."

Fate of dollar depends on swift solution

By Michael Mackenzie and Francesco Guerrera in New York
Financial Times
Published: July 13 2008 20:24

Any sign that the US government does not back Fannie Mae and Freddie Mac, pillars of the US mortgage market with debt widely held by foreign investors, could place the already weak dollar under further pressure.

The dollar slid last week as the euro rose to a three-month high of $1.5946 to sit less than a cent below its record peak of $1.6018, set in April. Analysts blamed some of the dollar’s fall on the drop in Fannie and Freddie’s share prices amid further distress in the US financial sector.

Non-US investors hold close to a record $1,000bn (€625bn, £505bn) of debt issued by US government-sponsored enterprises (GSEs), according to data from the Federal Reserve.

Over the past decade, non-US investors, including central banks, have increasingly sought the higher yields offered on this so-called agency debt compared with Treasuries.

In the past year, China has bought $66bn in agencies and only $12bn of Treasuries, while Russia bought $34bn of agencies and sold $22bn of Treasuries, according to Alan Ruskin, chief international strategist at RBS Greenwich.

They, like other investors, have long assumed that the debt issued by the GSEs is implicitly backed by the US government, valuing it closer to low-risk Treasuries than higher-risk corporate debt.

Investors will likely want to see a clear and uniform response from policymakers, and any sign of delay or vacillation could prompt further weakness in the dollar and the selling of agency debt.

“Some countries have made notable efforts to concentrate their buying in agencies,” said Mr Ruskin.

“The mix of large outstanding holdings and ongoing financing needs is one reason why a solution needs to be found fast, if the dollar is not to crack key levels, creating a wider problem.”

The idea that policymakers would prompt a run on the dollar and US debt markets as they try to shore up the GSEs is unthinkable, analysts warn.

Ajay Rajadhyaksha, head of US fixed income strategy at Barclays Capital in New York, said: “I don’t see any circumstance where the senior agency debt would default. A default would call into question the full faith and credit of the US government.”

The next test for the agency debt market looms on Monday, when Freddie Mac sells $3bn of short-term debt.

A nagging worry for investors is that there is still no clear consensus about whether the GSEs can count on US government support.

Mr Ruskin said: “Even if confidence is restored by making the government backing of this paper more explicit, it is bound to lead to some re-evaluation of the scramble for agency yield in a low yielding, high risk and weak dollar universe.”

Additional reporting by Nicole Bullock
Copyright The Financial Times Limited 2008

July 14, 2008

Treasury Acts to Shore Up Fannie Mae and Freddie Mac

New York Times

WASHINGTON — Alarmed by the sharply eroding confidence in the nation’s two largest mortgage finance companies, the Bush administration on Sunday asked Congress to approve a sweeping rescue package that would give officials the power to inject billions of federal dollars into the beleaguered companies through investments and loans.

In a separate announcement, the Federal Reserve said it would make one of its short-term lending programs available to the two companies, Fannie Mae and Freddie Mac. The Fed said that it had made its decision “to promote the availability of home mortgage credit during a period of stress in financial markets.”

An official said that the Fed’s decision to permit the companies to borrow from its so-called discount window was approved at the request of the Treasury but that it was temporary and would probably end once Congress approved Treasury’s plan. Some officials briefed on the plan said Congress could be asked to extend the total line of credit to the institutions to $300 billion.

The actions, which taken together could provide an overwhelming surge of capital to the companies, were the second time in four months that the housing crisis had prompted the government to scramble over a weekend to rescue a major financial institution. Last March, the Treasury Department engineered the sale of Bear Stearns to prevent it from going into bankruptcy and cause a shock to the financial system.

The plan was disclosed on Sunday evening to calm jittery markets overseas and on Wall Street in advance of a debt sale by Freddie Mac on Monday morning. Officials said that after talking to senior lawmakers through the weekend, they expected that Congress would attach the proposals to a housing bill that could be completed and sent to the White House for approval as early as this week.

“The president has asked me to work with Congress to act on this plan immediately,” the Treasury secretary, Henry M. Paulson Jr., said Sunday on the steps of the Treasury building. “Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.”

While senior Democratic and Republican officials in successive administrations have for many years repeatedly denied that the trillions of dollars of debt Fannie and Freddie issued is guaranteed, the package, if adopted, would bring the Treasury closer than ever to exposing taxpayers to potentially huge new liabilities. The two companies could face significant new losses this year as the wave of housing foreclosures continues. Officials seemed to suggest, however, that they had little choice but to intervene.

Over the weekend, Treasury officials sought assurances from Wall Street firms that the $3 billion auction by Freddie Mac of short-term debt would go off without a hitch. While $3 billion is a relatively small sum for an institution of Freddie’s size officials said they did not want to risk even a small misstep that could set off a new round of problems.

The government officials said that the more drastic alternative that has been considered — placing one or both companies under the control of a government-appointed conservator — would be done only as a last-ditch measure if the intermediate steps failed to restore confidence. The failure of just one of the companies could be catastrophic for economies around the world.

The officials said they were prompted to act because, despite repeated assurances by top officials that the companies had adequate cash to weather the current financial storm, Fannie and Freddie suffered a withering blow of confidence last week when their stocks plummeted on the New York Stock Exchange. As a result, Freddie faced an uncertain debt offering on Monday.

The companies, known as government-sponsored enterprises, or G.S.E.’s, touch nearly half of the nation’s mortgages by either owning or guaranteeing them, and the debt securities they issue to finance their operations are widely owned by foreign governments, pension funds, mutual funds, big companies and other large institutional investors.

“G.S.E. debt is held by financial institutions around the world,” Mr. Paulson said in his statement. “Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.”

The proposal would give the Treasury secretary authority to determine when to invest in the companies or extend loans to them. Those purchases would be made with the agreement of the companies.

Officials said the proposed investment and lending elements of the plan were to last two years.

While the Treasury did not specify the size of the packages, officials briefed on the plan said they were told by administration officials that, to be meaningful, Congress should consider extending the line of credit to the two institutions to $300 billion.

Each company now has a $2.25 billion credit line, set nearly 40 years ago by Congress. At the time, Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion. Today the two companies also hold or guarantee loans valued at more than $5 trillion, about half the nation’s mortgages.

Lawmakers said that as part of the plan, the administration called on Congress to raise the national debt limit. And it asked Congress to give the Federal Reserve a role in setting the rules for how big a capital cushion each company must hold. Giving the Fed a consulting role in the companies’ oversight is seen as another way to reassure markets.

Initial reaction to the plan by some Congressional Democrats was positive.

An early endorsement came from Senator Charles E. Schumer, the New York Democrat who is also a senior member of the banking committee.

“The Treasury’s plan is surgical and carefully thought out and will maximize confidence in Fannie and Freddie while minimizing potential costs to U.S. taxpayers,” Mr. Schumer said. “While Fannie and Freddie still have solid fundamentals, it will be reassuring to investors, bondholders and mortgage-holders that the federal government will be behind these agencies should it be needed.”

Representative Barney Frank, Democrat of Massachusetts, and one of the authors of the housing legislation, said he supported the Treasury proposal. He said he expected the plan would be included in the housing bill, which he said would be approved, sent back to the Senate and likely land on the president’s desk by the end of the week.

“The general thrust of what they’re doing is right,” said Mr. Frank, the chairman of the House Financial Services Committee.

Senator Barack Obama of Illinois, the presumptive Democratic presidential nominee, told reporters in San Diego on Sunday that any government action to rescue the two mortgage companies should be done from the perspective of homeowners, “not just shareholders and investors and C.E.O.’s of companies.”

His presumed Republican opponent, Senator John McCain of Arizona, said last week that he expected the government would do all it could to prevent the failure of either company.

The administration’s announcement was made after senior officials from the Treasury and the Federal Reserve spent Saturday and Sunday closely monitoring preparations by Freddie Mac to raise money to help meet its short-term financing needs. Officials said they were watching to see if the steep declines last week of Freddie and Fannie stock would spill into the debt market and undermine the confidence of lenders.

A senior official said that the administration had been receiving mixed signals from Wall Street about the Monday auction. But other officials denied that the prospect of a weak debt offering had motivated the Treasury to rush out its rescue plan.

“There is nothing that motivated us to act tonight that changed from Friday night,” said a Treasury official. “There has been no further deterioration in the markets.”

Daniel H. Mudd, the president and chief executive of Fannie Mae, said the company “appreciates today’s announcements and the expressions of support.”

“We continue to hold more than adequate capital reserves and maintain access to liquidity from the capital markets,” Mr. Mudd said. “Given the market turmoil, having options to access provisional sources of liquidity if needed will help to strengthen overall confidence in the market.”

Richard F. Syron, chief executive of Freddie Mac, said, “This affirmation of the important role of the G.S.E.’s, and that we should continue to operate as shareholder-owned companies, should go a long way toward reassuring world markets that Freddie Mac and Fannie Mae will continue to support America’s homebuyers and renters.”

On the prospect that the government could buy shares, Sharon J. McHale, a spokeswoman for Freddie Mac, said, “It’s important to note that our understanding with Treasury is that any agreement to purchase equity can only occur with the mutual agreement of both parties.”

Reporting was contributed by Jenny Anderson and Gretchen Morgenson from New York; Charles Duhigg from Macatawa, Mich.; and David Herszhenhorn and Carl Hulse from Washington.

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