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Bloomberg.com: Bonds: "U.S. Should Boost Fannie Mae, Freddie Mac Credit Line (Update2)

By Shannon D. Harrington

U.S. Should Boost Fannie Mae, Freddie Mac Credit Line (Update2)

By Shannon D. Harrington

July 11 (Bloomberg) -- The U.S. government should increase its $2.25 billion credit line to Fannie Mae and Freddie Mac to as much as $100 billion to bolster investor confidence that it won't allow them to fail, according to Barclays Capital.

The government should expand the credit line to at least $50 billion as a ``grand gesture'' to ease investor concern, Ajay Rajadhyaksha, head of U.S. fixed income strategy at Barclays Capital in New York, said in a telephone interview yesterday. Analysts at Bank of America Corp. and Credit Suisse Group also said an expanded credit line may comfort investors.

``The best way to squelch these worries is to extend that $2 billion,'' Rajadhyaksha said. ``The whole point is to make sure that you buy them time by instilling confidence in their debt if nothing else. Given how negative sentiment is out there, if I were Treasury, I wouldn't just wait.''

Fannie Mae shares have dropped 49 percent this week and Freddie Mac's have plunged 58 percent on concern that the two largest U.S. mortgage finance companies don't have enough capital to weather record home foreclosures and price drops. Treasury Secretary Henry Paulson today said the government backs the companies ``in their current form.''

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default.

The two companies own or guarantee about half the $12 trillion in U.S. home loans outstanding.

Fannie Mae and Freddie Mac debt prices rose today and the cost to protect them from default plunged amid speculation that the government is making plans for a bailout.

Government Takeover

A government takeover of one or both companies is among several options being weighed by the Bush administration, said Joshua Rosner, an analyst with Graham Fisher & Co., who met with officials in Washington yesterday. The government may push for the firms to be placed in a conservatorship if their problems get worse, he said. A government-led takeover would likely make the common stock of each company worthless.

Boosting the government's credit line to the companies would ``have a dramatic psychological effect on senior debt holders and would serve to buy time to address the underlying capital issues,'' though it would represent ``a tiny fraction'' of their overall balance sheets, Bank of America interest-rate strategists led by Michael Cloherty in New York wrote in a note to investors yesterday.

Potential Options

A credit line extension, or a lending facility similar to the one the Federal Reserve created to prevent a collapse by investment banks in March, are potential options for the government, Credit Suisse interest-rate strategist Ira Jersey said on a conference call with investors today.

``That would give a lot of comfort to a lot of investors in the fixed-income securities,'' said Jersey, who is based in New York.

Fannie Mae and Freddie Mac don't need an immediate capital injection, Rajadhyaksha said.

``The only thing that worries me is that the debt at some points of time during this week has started to react to what is happening to their equity,'' he said.

Credit-Default Swaps

Credit-default swaps tied to the senior debt of the two companies and yields relative to benchmark rates widened this week as stock-market concerns began to filter into debt markets.

Former St. Louis Federal Reserve President William Poole said in an interview this week that the two companies are insolvent under fair value accounting rules and the chances are increasing that the government will need to bail them out.

Congress, which chartered Fannie Mae and Freddie Mac decades ago to boost home financing, has lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger jumbo mortgages to help revive the housing market.

Credit-default swaps linked to the debt of Fannie Mae dropped about 17 basis points to 60 basis points today, according to CMA Datavision. Contracts on McLean, Virginia-based Freddie Mac declined 19 basis points to 58 basis points. Before today, both contracts had more than doubled in the past two months.

Yields on 10-year notes from Fannie Mae and Freddie Mac relative to interest-rate swaps of similar maturity fell more than 19 basis points today, according to data compiled by Bloomberg. Yields for Fannie fell to 1.9 basis points below swaps, the lowest since June 5. Yields for Freddie fell to 4.4 basis points more than swaps, the lowest since June 16. A basis point is 0.01 percentage point.

To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net
Last Updated: July 11, 2008 17:39 EDT