The Market Story

Return to Article

Stock Market Locks In Mortgage-Bailout Gains

Mike Taylor

Stocks on Wall Street rallied sharply into the close Monday to lock in sizable gains prompted by a U.S. government takeover of mortgage giants Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote).

The Dow Jones Industrial Average gained 289.78 points, or 2.6%, to 11,510.74, and the S&P 500 climbed 25.48 points, or 2.1%, at 1267.79. The Nasdaq added 13.88 points, or 0.6%, to 2269.76.

On Sunday, the Treasury Department and Federal Housing Finance Agency said they would temporarily seize Fannie Mae and Freddie Mac, replacing the mortgage giants' CEOs, buying preferred shares of the companies and offering additional capital support as Fannie and Freddie wade through increasing home-buyer defaults.

The two government-sponsored entities -- which have issued more than $5 trillion in mortgage-backed securities and credit -- are central to the health of the U.S. home-lending market and are lynchpins of the financial sector. Investment bank Morgan Stanley (MS Quote) aided the government in its takeover of the firms.

Although news of their takeover was buoying the blue-chip indices, shares of the GSEs were getting destroyed. Fannie plummeted 90% to 73 cents, and Freddie got an 83% haircut to 88 cents. Citigroup downgraded the stocks to sell from buy, and Lehman revised its rating on the pair to equal weight from overweight.

"I don't think it's a sucker's rally," said Marc Pado, U.S. market strategist at Cantor Fitzgerald. The takeover was necessary, he said. "Yeah, it's not going to end the crisis, but it's a step in the direction of ending it," he said. Although Pado believes the government should have acted sooner, he said the takeover has restored confidence to the market.

Providing capital to Fannie and Freddie was the most important step the Treasury and FHFA took. "Making sure that that capital is available and keeping the entities functioning is what the market needed," he said.

The takeover relieves some of the market's concern about the credit crisis and housing market, said Robert Pavlik, chief investment officer at Oaktree Asset Management. "However, I think it's going to take additional time before those concerns are fully resolved," Pavlik said. He expects stocks to get a short-term bounce on the takeover until the market redirects its attention to the global economic slowdown.

"There are still problems out there. Lending standards are still going to be high. Banks' balance sheets are still going to be screwy," said Pavlik. He predicts that high inflation and a weak labor market and high consumer debt will continue to hinder the economy. "Are people going to be able to refinance their homes to pay their credit cards and buy new cars? The answer's no," he said.

Pavlik said that the rally in the financial sector needs to be accompanied by substantial volume and solid breadth: "You could say there's a lot of cash sitting on the sidelines, but I think it's a lot of smart money that won't necessarily get drawn into a bounce in the market." He said that Goldman Sachs' (GS Quote) quarterly earnings, due next week, could let a lot of air out of the sector's rally.

From the taxpayer's perspective, the takeover is an open commitment, said Dan Seivers, professor of finance at San Diego State University. "[The government's] long-term fiscal is getting pretty bad. We have huge budget deficits in the long run, and this will potentially make that worse."

The benefit of the bailout, said Seivers, is that mortgage rates are likely to decline slightly. He said that the government-sponsored entities business model, which privatized gains and left taxpayers on the hook for losses, was seriously flawed and now will be changed. He said a takeover was inevitable. "We avoided disaster, and I think that's always a good policy," he said.

In other company news, struggling brokerage Lehman Brothers (LEH Quote) announced over the weekend that it would replace two members of senior management as it prepares to lay off between 1,000 and 1,500 employees. Shares fell 13% to $14.15.

The Wall Street Journal also reported that Wachovia (WB Quote) is looking to take David Zwiener of the Carlyle Group as its new chief financial officer. Wachovia climbed 13% to $18.99.

Elsewhere in the financials, Washington Mutual (WM Quote) announced a shakeup in its top brass. CEO Kerry Killinger, who oversaw $19 billion in mortgage-related writedowns during his tenure, is stepping down. Alan Fishman, chair of Meridian Capital and president of Sovereign Bancorp (SOV Quote) will take over the chief executive spot. WaMu dropped 3.5% to $4.12.

Financial names and homebuilding stocks were among the biggest gainers. The Financial Select Sector SPDR(XLF Quote), which tracks the financial-services group, was up 4.3% at $22.68. Homebuilding names were also broadly rising. The SPDR S&P Homebuilders (XHB Quote) jumped 9.3% to $21.73.

Cigarette maker Altria (MO Quote) said it would buy chewing-tobacco producer UST (UST Quote) for about $10 billion in cash. Altria climbed 0.1% to $20.97, and UST added 2% to $68.90.

United Airlines (UAUA Quote) shares briefly fell to $3 after a news outlet accidentally posted on its Web site an outdated report that the airline was filing for bankruptcy, according to a report by CNBC. Shares ended the day down 11% at $10.92.

As for commodities, the price of crude oil was up 14 cents to close at $106.34. Gold finished unchanged at $802.50.

Longer-dated U.S. Treasury prices were climbing. The 10-year was adding 11/32 to yield 3.66%. The 30-year was up 22/32, yielding 4.26%. The dollar was gaining on the euro, yen and pound.

Overseas exchanges, including the FTSE in London, the Dax in Frankfurt, the Nikkei in Japan and the Hang Seng in Hong Kong, were making substantial gains.