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Why Markets Want Fannie, Freddie to Be Resolved

Jeff Cox, |Special to CNBC.com
Thursday, 21 Aug 2008 | 1:48 PM ET

The eventual fates of mortgage giants Fannie Mae and Freddie Mac—along with Wall Street titan Lehman Brothers—could prove to be a watershed in the financial crisis and help restore confidence in the stock market, analysts say.

Wall Street
Wall Street

The immediate impact of a collapse of any of the firms would likely create panic selling on Wall Street, these analysts believe. Yet it also could help convince investors that the worst had finally passed for the battered banking and housing markets, helping to bring a recovery in stocks and the economy.

"One of the things that this market has been missing is a real panic," says Mike Larson, market analyst at Weiss Research's Money and Markets investment newsletter. "If we were to see an actual failure, a nationalization, some kind of take-under deal ... if we were to see something like that and we were to get some panic in the short term, in the long term that would be helpful to clear out those sellers that are left."

The uncertainty over what will happen to Fannie, Freddie and Lehman—and when—is probably the greatest factor roiling Wall Street and the stock market.

The fate of Fannie and Freddie is considered more crucial right now than Lehman and so would have the greater impact in forming a market bottom, analysts say.

Fannie and Freddie provide a vital role in the mortgage process by buying mortgages from lenders that don't want the loans on their books for the long term. With Fannie and Freddie struggling with capital and perception issues, they aren't buying as many loans and are thus crimping banks' ability to write mortgages, which in turn chills buying in the housing market.

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Fannie Mae and Freddie Mac CEOs Richard Syron and Daniel Mudd are in the hot seat, with Howard Glaser, mortgage industry consultant; Jake Zamansky, Zamansky & Associates and CNBC's Bill Seidman

"Unless we find a way to continue Fannie Mae and Freddie Mac in their current form we don't have a mortgage market," Howard Glaser, a mortgage industry consultant, said on CNBC.

See Glaser's analysis, along with other commentary on Fannie and Freddie, in the video at left.

When Bad News Becomes Good News

The seemingly inevitable move by the federal government to rescue Fannie-Freddie initially would shake the market.

Common stock shareholders likely would get wiped out, while those holding subordinated bonds also likely would be hurt because recapitalization likely would come in the issuance of preferred shares.

But once the dust clears and Fannie and Freddie can get back to lending again, that would likely be a catalyst to send the market higher. Combine that with a possible takeover of Lehman Brothers, which also could hurt shareholders, there would be greater clarity on Wall Street.

"The scenario is the cross feelings of when are we going to get this behind us, versus once we do how much better will it be, versus how much more we still don't know," says Michael Kresh, president of M.D. Kresh Financial Services. "Those events would bring us much closer to a final washout. I still think as we go forward if these banks don't put everything on the table, everything that's ugly, we could have another six months to two years of this bleeding in the financials."

To be sure, there was widespread belief that the Bear Stearns situation marked a capitulation moment, when everything was on the table and supposedly in clear view. But that only lasted as long as the next big series of banking surprises, which reignited fears that no one even knew how much damage was out there and it would take a major event to send the all-clear signal on Wall Street.

The integration of Fannie Mae and Freddie Mac, through sheer size, in not only the banking but also the housing industry makes this more of a watershed moment.

The Bear Stearns rally "didn't last because what we've been having here is this ongoing period of mini-crisis followed by mini-bailout then a few months of calm, then the next crisis," Larson says. "The credit markets are much larger, much more integrated. This is a real deleveraging situation."

What About Lehman?

As a market event, the collapse of Lehman Brothers , or a merger along the lines of JPMorgan Chase's asbportion of Bear Stearns, also would be a seismic event, though not on the order of Fannie and Freddie.

"The Lehman Brothers situation is extremely disturbing because they're trying to shop one of their most profitable assets to stay in business," Kresh says, referring to the possible sale of Lehman's investment management arm Neuberger Berman. "If you sell your most profitable asset you're not going to stay in business, you're just buying time."

"Although Lehman is an important company and an important name, it's not gigantic in size," Kresh adds. "It's more a case of another company that gambled and got itself stuck. Fannie and Freddie can't be allowed to fail."

At the same time, some see the dark clouds over the entire financial sector as an opening for buyers with an appetite for risk.

"I suspect that this offers a tremendous buying opportunity for the markets," Michael Browne, portfolio manager for Sofaer Global Research, said on CNBC. "It's the sort of crash, the sort of failure that you see that tends to market bottoms."

Kresh isn't as convinced.

"The risk-return rate just isn't there, and the individual investor won't be able to move quickly enough to protect themselves," he says. "This is a trader's market for these kinds of stocks."

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