NYTimes.com
Mortgage Fears Send Global Shares Down
Tuesday July 8, 2008 12:35 pm ET
By CHARLES DUHIGG and DAVID JOLLY

NEW YORK — As U.S. home prices decline and Washington struggles to end the economic malaise, Wall Street is starting to send a sobering message: The worst is yet to come.

One of the strongest warning signs came as the week began, when shares of the most important U.S. mortgage companies, Fannie Mae and Freddie Mac, plummeted. After falling almost continuously over the past month, in just one day Freddie Mac tumbled another 18 percent and Fannie Mae lost 16 percent amid concerns that the companies would need to raise billions of dollars in fresh capital.

With renewed prospects for turmoil in the financial markets, global stocks fell Tuesday from Sydney to Stockholm.

“Across the board, there are probably more write-downs to come,” Florian Esterer, a fund manager at Swisscanto Asset Management in Zurich, said. Investors need to look beyond the subprime problems, he said, and consider the decline in the quality of home-equity loans, credit card debt and commercial real estate — problems associated with the end of a “traditional credit cycle.”

Banks seem to be “in denial” about the degree of problems, he said: “I think there is much more pain to come than they are telling you.”

Fannie Mae and Freddie Mac are the largest U.S. buyers of home mortgages, and traditionally the government’s backstop for the housing economy. But with the plunge Monday, each of these “government-sponsored enterprises” has now lost more than 60 percent of its market value this year. The declines, along with a falling stock market and growing unease about the possibility of more losses at big banks, reflect a growing consensus among investors that the current housing slump will last longer, and prove more severe, than initially feared.

As a result, investors are signaling that they are far from convinced that any enterprise — even ones with the strongest backing — can successfully navigate these choppy waters, and that those who do survive will pay dearly.

In Asia, the Tokyo benchmark Nikkei 225 stock average fell 2.5 percent. The Hang Seng index in Hong Kong fell 3.3 percent, and the S&P/ASX 200 index in Sydney fell 1.4 percent.

Mitsubishi UFJ Financial, the largest publicly traded Japanese bank, fell 3.4 percent in Tokyo, while its rival Mizuho Financial fell 3.7 percent.

In London morning trading, the FTSE 100 index was down 2.7 percent, while the DJ Euro Stoxx 50 index, a barometer of euro zone blue chips, was down 2.3 percent. The DAX in Frankfurt fell 2.4 percent, while the CAC 40 in Paris also fell 2.4 percent.

UBS, the Swiss banking giant whose shares have fallen 58 percent this year, fell 4.5 percent in Zurich. Its crosstown rival, Credit Suisse fell 4.8 percent. HSBC Holdings, the biggest European bank, fell 2.6 percent in London.

Oil company shares fell as crude oil slipped. Royal Dutch Shell, the largest European oil company, fell 2.6 percent in London. BP dropped 2.7 percent.

“Everything points to a lot more bad news to come,” said Paul Miller of the Friedman, Billings, Ramsey Group in Arlington, Virginia. “If Fannie and Freddie are vulnerable, it means no one is absolutely safe.”

Representatives of Freddie Mac and Fannie Mae declined to comment on their stocks’ performances Monday. Freddie Mac closed at $11.91, the company’s lowest price since 1994. Fannie fell to $15.74, its lowest level since 1992.

The stocks’ dips were part of a broad decline in U.S. financial shares. Shares of Bank of America and JPMorgan Chase fell more than 3 percent.

The decline in Freddie Mac and Fannie Mae comes at a delicate time for the financial markets. In coming weeks, many of the world’s largest financial institutions — including Citigroup and Merrill Lynch — will report results that investors worry will be disappointing.

Lehman Brothers, which some on Wall Street worry might run into trouble like Bear Stearns, continues to struggle to restore confidence among investors. Lehman’s share price fell almost 8 percent Monday.

If banks’ results are as gloomy as anticipated, the news could depress other sectors of the stock market and further sap consumer confidence, which is already battered by rising oil costs, mounting credit-card defaults and prices that are rising due to spiraling energy fees and a weakening dollar.

Worldwide, banks and brokerage have written down the value of the assets they hold, notably those linked to mortgages, by more than $400 billion since the beginning of last year. In April, the International Monetary Fund said total losses for banks, insurance companies and investment funds may reach $945 billion, and some forecasters say they bill could be even higher.

“The economic story has gotten worse and worse and worse, and every financial institution seems like its in free fall,” said Steve Persky, chief executive at Dalton Investments in Los Angeles. “It’s not clear at all when this ends.”

The gloomy news also threatens to further shrink Washington’s influence over the economy. Legislators are widely expected to approve a housing rescue bill by the end of the month. That legislation will overhaul the regulatory structure for Freddie Mac and Fannie Mae, which are government chartered enterprises, and will force the two companies to hand over hundreds of millions of dollars each year to refinance troubled home loans.

But the reform legislation will also likely bolster the odds that taxpayers will foot the bill if either company falters.

“If Fannie or Freddie ever became critically undercapitalized, their regulator would have no choice but to put in place a taxpayer rescue,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a consulting company.

To ward off that possibility, in recent weeks, the U.S. Federal Reserve chairman, Ben Bernanke, and Treasury Secretary Henry Paulson Jr. have both urged Freddie Mac and Fannie Mae to raise additional capital from investors.

But as share prices at the companies have declined, raising new funds has become increasingly difficult. Freddie Mac, for instance, said May 14 that it intended to sell $2.75 billion in new common stock to investors. Since then, the company’s stock price has declined by 56 percent.

As a result, Freddie Mac will have to issue more than twice as many shares to raise the new funds. When those new shares hit the market, they are likely to further push the company’s stock price down, and make it even harder for Freddie Mac to recover when the market eventually rebounds.

Similar problems are likely to plague investment banks and other financial firms also hoping to raise new money. So, as the housing market declines, there are new concerns that the financial spigot that keeps Wall Street and the economy afloat may be closing.

It is unclear precisely why Fannie Mae and Freddie Mac suffered so greatly Monday. Early in the day, analysts at Lehman Brothers estimated that a proposed change in accounting rules would require the companies to raise about $75 billion in additional capital — an enormous sum for two companies that have already asked investors for $25 billion since December.

But other analysts disputed Lehman’s conclusions, and even the Lehman report predicted the proposed rule changes would not be enacted, or that the two mortgage companies would be exempt.

Additionally, Freddie Mac and Fannie Mae were battered by news Monday that their cost of borrowing, when compared to what the government pays, had increased to their widest spread since March, when it set a 22-year record. And some analysts raised fears that the companies would suffer from chaos in the private mortgage insurance market, where Fannie Mae and Freddie Mac have sought protections from the risk of borrower defaults.

“These companies, and the economy in general, are fighting a lot of demons right now,” said Sean Egan, managing director of Egan-Jones Ratings, an independent credit ratings firm. “If things don’t get turned around, you’re going to see more downward pressure on home-building, on financial institutions, on spending. There’s not a lot of places that will be protected.”

<i>David Jolly reported from Paris.</i>



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