(AFP) – Sep 8, 2008

WASHINGTON (AFP) — The US takeover of struggling mortgage giants Fannie Mae and Freddie Mac offers hope for an easing of the credit and housing crunch while putting the government's finances on the line, analysts have said.

The initial market reaction was overwhelmingly positive to Sunday's announcement of a government conservatorship -- the equivalent of a bankruptcy reorganization under the aegis of the government.

China's central bank has greeted the developments positively describing the the US takeover of the struggling mortgage giants as "positive", given the billions of dollars of exposure of Chinese banks, state media has said.

"Chinese investors have a certain amount of exposure" to the companies, central bank governor Zhou Xiaochuan said, according to the China Daily.

Yet some analysts said the bump may be short-lived as the housing crisis drags on.

Under the plan, the two firms will get government-appointed chief executives and shed their mission of shareholder profit. The Treasury agreed to inject 100 billion dollars in each if needed.

The takeover "significantly reduces the near-term threat to the housing market, financial system and broader economy," said Mark Zandi, chief economist at Economy.com.

As expected, shares in the two firms were nearly wiped out in trade Monday -- Freddie Mac plunged 83 percent to 88 cents and Fannie Mae slid 89 percent to 73 cents in closing trade.

"Although Fannie and Freddie shareholders will lose, and the move will cost US taxpayers tens of billions of dollars, the housing market will receive an important boost via lower mortgage rates and more available mortgage credit," Zandi said.

In what is likely the largest US government intervention in the private sector, the plan effectively adds some 5.4 trillion dollars in potential liabilities from the two firms to the Treasury -- equivalent to the entire federal debt.

The move constitutes a massive government intervention to contain the damage from the worst housing slump in decades, which has rippled through the banking system and led to multibillion-dollar losses for Fannie and Freddie.

The hope is that by opening up the vast coffers of the US government to the government-sponsored enterprises (GSEs), confidence will return to the housing and financial system, minimizing any losses.

"Overall, this lifts a black cloud off of the financial markets," said Andrew Busch at BMO Capital Markets.

One potential problem is that the federal government now becomes the source for mortgage capital, placing its own balance sheet on the line.

"The lender of last resort is no longer only the Fed, but also the US Treasury," said Ed Yardeni at Yardeni Research.

"In effect, the federal debt has just increased from about five trillion to 10 trillion dollars."

Fannie Mae was originally a government agency created during the Great Depression to help provide liquidity for housing. It was privatized in 1968 and Freddie Mac was chartered by Congress in 1970 to provide competition.

But many officials and analysts argue there was a contradiction in the mission of the two, which tried to maximize results for shareholders at the same time seeking to lower the cost of mortgage credit.

Treasury Secretary Henry Paulson argued that the US economy cannot recover without a stabilization of the housing market, which cannot occur without fresh flows of credit through a functioning Fannie and Freddie.

"Whether this is the beginning of the end or merely the end of the beginning is yet to be determined, however it is certainly the hope that this move will begin to calm the housing market and allow mortgage money to once again flow," said Paul Nolte, analyst at Hinsdale Investments.

Some remained skeptical.

"The plan addresses the issue of liquidity but not solvency," said Joseph Brusuelas, chief economist at Merk Investments.

He said rising defaults would likely provide "a continued challenge to the capital base of both Fannie and Freddie" and put taxpayers at risk.

"There is still a lot of heavy lifting needed for the economy to get back on track and other elements of the financial complex to be put back together that would result in the banks beginning to extend credit needed to stimulate long-term economic growth," noted Fred Dickson, analyst at DA Davidson & Co.

Robert Eisenbeis, economist at Cumberland Advisors, said "there are many problems and questions" about the plan.

"What Treasury clearly has done is punted the actual dirty details of handling these two hot potatoes to the next administration, with no clear exit strategy nor any practical solutions to the fundamentally flawed business model that Secretary Paulson referred to on several occasions," he said.

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