Investors' growing belief in the likelihood of a federal bailout of home-funding giants Fannie Mae and Freddie Mac triggered a rally in the debt prices of the two companies in the US yesterday while a steep fall in their shares prices abated.
Debt investors bet the securities will get a US guarantee even if shareholders are wiped out by a federal rescue of the two government-sponsored enterprises (GSEs), which own or back almost half of all outstanding US mortgages.
Shares of Fannie Mae and Freddie Mac erased earlier losses of about 20 per cent as growing speculation of an imminent government bailout forced investors to buy back shares to exit bets made in hopes of a further decline.
Freddie shares fell 2.8 per cent to $3.16 while Fannie gained 10.2 per cent to $4.85. So far this week, Fannie shares have fallen 39 per cent and Freddie is down 46 per cent.
The two GSEs have reported losses for the past four quarters, and rising mortgage delinquencies cut into the value of their assets and capital. However, they meet regulatory capital requirements and are successfully rolling over their debt on the regular schedule, limiting the need for any nationalization by the government.
As the United States suffers the worst housing market downturn since the Great Depression, the two GSEs' ability to fund mortgages through the issuance of debt is considered crucial for the housing market and economy.
The price of the debt issued by Fannie and Freddie has surged relative to US Treasuries in the past two days, however, on the view that Congressional backing for a bailout mandated in July this year will secure repayment.
Investors are closely watching the performance of the companies' debt, given that the two GSEs will need to roll over $225 billion of debt by the end of September, according to Barclays Capital.
Both agencies have demonstrated in debt sales this month that they still have ready access to the capital markets, albeit at a higher cost.
The ongoing ability of the GSEs to finance the purchases of mortgage from private lenders, freeing up money for more lending, is critical to the housing market. Many of Fannie's and Freddie's private competitors shut their doors after record foreclosures on riskier loans in the past year.
A new Freddie Mac five-year note was sold on Tuesday at record 1.13 percentage point yield premium over Treasuries. The pricing enticed enough demand to cut that premium to 0.98 percentage points on Wednesday and about 0.90 percentage point at on Thursday.
However, a bounce in the two companies shares prices could be expected if the government acts to support the two largest US home funding companies without eliminating value for existing shareholders.
The Wall Street Journalreported late yesterday that Freddie executives are sounding out private-equity and other investors about buying new common and preferred shares, but said such efforts faced investor fears that a bailout involving an equity purchase would dilute the value of any investment.