ANALYSIS:Despite the broad welcome for the US government's effective takeover of Fannie Mae and Freddie Mac, the action underlines the depth of the crisis, and it would be unwise to think it has passed, writes PROINSIAS O'MAHONY
'WE LIKE it," said Bill Gross, manager of the world's biggest bond fund. A "welcome decision", said ECB president Jean-Claude Trichet. "Very positive," said Goldman Sachs. A "necessary step" that should "help increase the availability of mortgage credit", according to Merrill Lynch economist and long-term bear David Rosenberg.
It's fair to say that reaction to last weekend's effective government takeover of beleaguered mortgage giants Fannie Mae and Freddie Mac has been positive. Financial stocks across the world enjoyed strong gains as investors bet that the move will cushion the downside to housing prices and boost the availability of mortgage finance.
American authorities had little choice but to take the option they did. The two firms guarantee almost half of the $12 trillion (€8.5 trillion) US mortgage market and are "critical to turning the corner on housing", as treasury secretary Henry Paulson put it.
Since 2007, they've lost more than $10 billion and it had become increasingly obvious that they could not "continue to operate safely and soundly and fulfil their critical public mission".
A vital cog for the US housing market, investors had lost all confidence in the troubled duo, which faced serious capital shortfalls.
Whilst the bailout may eventually cost the American taxpayer up to $200 billion, capital injections are designed to be as small as possible.
Money is to be injected on an as-needed basis. With the cost of borrowing for Fannie and Freddie destined to fall, now that their future has been secured, lower mortgage rates are expected.
Gross, who warned on Friday that the world was facing a "financial tsunami" unless government stepped in, said that the "Category 4 hurricane" headed for financial markets "has been downgraded to a tropical storm".
It would be unwise, however, to think that the crisis has passed. That the US government has effectively taken over the American mortgage market only serves to underline the depth of the crisis.
Just last Friday, former Federal Reserve chief Paul Volcker pointed out that growth in the US economy in this decade will be the slowest of any decade since the Great Depression. Furthermore, he described the current financial system as "dysfunctional", a "polite way of saying it failed".
As for housing, the fundamentals are still iffy, to say the least. Compared to income and rents, prices remain elevated and supply continues to outstrip demand.
The latest takeover may lead to slightly lower mortgage rates but lending standards will remain tight and it will take some time to wring excess inventory out of the system.
Prof Robert Shiller is particularly pessimistic. During the depression era, house prices fell by 30 per cent. With prices having already fallen by 20 per cent and the rate of decline only beginning to peak, Shiller expects that figure to eventually surpass the declines of the 1930s.
It's also worth noting that markets have been here before. The hope that the Fannie/Freddie takeover marks some kind of cathartic climax to the credit crisis is not a new one. In fact, over the last year, US authorities have released no fewer than six weekend press releases in response to major financial turmoil
Last August, the US Federal Reserve officially recognised the credit crisis by cutting the discount rate at which they lend to banks.
In December, they announced a major extension of credit facilities to cash-strapped banks. January saw an emergency 0.75 per cent interest rate cut, the biggest in decades That triggered a double-digit bounce for global equity markets that soon fizzled out. Come March, increased panic saw the
bailout of the once-mighty Bear Stearns. Then, too, markets reacted as if this "had" to represent the climax. Another double-digit bounce ensued, as CEOs all over Wall Street assured investors that "the worst is behind us".
It wasn't. Markets gave up their gains and then some. In July, the US treasury announced that it was prepared to extend its credit lines to Fannie and Freddie as well as invest in its equity. Treasury secretary Henry Paulson reckoned that it would not come to that. "If you have a bazooka in your pocket and people know it, you probably won't have to use it."
His optimism was ill-founded, however. Similarly, market optimism faded away and equities were falling back to the bear market lows seen in July until last weekend's latest rescue operation.
That adage that "the darkest hour is before the dawn" encapsulates the market's attitude throughout the credit crisis. The rallies have been getting shorter, however, and it remains to be seen if things will turn out different this time.
As for the efforts of the authorities,
David Rosenberg says that they have been consistently behind the curve and that "there is an appearance that the government is continually underestimating the magnitude of the stresses engendered by the credit bubble".
Most of all, however, is the element of the unknown. The credit crisis has been very difficult to quantify and predict from the very beginning. After unveiling an emergency funding scheme for banks last April, Mervyn King of the Bank of England estimated that banks might tap it to the tune of £50 billion. Last week, one analyst suggested that the end figure was likely to be four times that.
Globally, writedowns have been continually revised upwards over the last year. Just five months ago, Standard Poor's estimated that the end total might hit $285 billion. The IMF now expect that figure to be nearer $1 trillion, with others predicting greater losses still.
The sense of uncertainty was perfectly captured in Goldman Sachs's recent downgrading of insurance giant AIG. "The intricacies of AIG's business are so complex that management may not even know the extent of the company's ultimate exposures, let alone losses," the analysts said.
The latest developments, while welcome, do not necessarily represent the climax everyone is hoping for. There are likely to be further twists and turns along the way.
• Proinsias O'Mahony is a financial journalist