Stocks Drop on Worries About Fannie, Freddie

Shares of large mortgage backers got beaten down again, while another spike in crude oil haunted investors

Even with a late-session recovery, stocks ended a turbulent week solidly lower Friday amid continued worries that the country's biggest backers of home mortgages, Freddie Mac (FRE) and Fannie Mae (FNM), need to raise fresh capital. Treasury Secretary Henry Paulson indicated that the government would not bail them out yet, saying Friday morning that "today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission."

Then, late in the trading session, reports circulated that Federal Reserve Chairman Ben Bernanke opened the discount window to the beleaguered government sponsored enterprises (GSEs), providing some support for the stocks.

Earlier, Paulson said his department is continuing discussions with Fannie Mae and Freddie Mac as the companies' stock prices continued to slide. Shares of Freddie ended down 3% to 7.75, after touching a new low of 3.89. Fannie recovered less ground, ending down 22% to 10.25, after touching a new low of 6.68.

This week's dramatic drops in these stocks have triggered speculation about whether Fannie and Freddie will need to raise capital and get help from the government. The New York Times reported that senior Bush administration officials are considering a plan to have the government take over Freddie and/or Fannie and place them in a conservatorship if their problems worsen. The article states: "Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee -- which could be staggering -- would be paid by taxpayers."

The federal government will not only need to stand behind the GSEs but will need to encourage them to continue growing their book of business, said Jan Hatzius at Goldman Sachs in a note Friday. "The key significance of Fannie Mae and Freddie Mac in the current economic climate is their ability to soften the impact of the credit crunch," he wrote. He figures that of the almost $25 trillion of lending capacity to the nonfinancial private sector, roughly half (on-balance-sheet lending by banks and quasi-banks plus private-label securitization) is either stagnant or shrinking. "This means that the other half -- of which the $5.3 trillion Fannie/Freddie book of business is the biggest component -- needs to grow rapidly to generate at least some credit growth over time," Hatzius wrote.

On Friday, the Dow Jones industrial average finished down 128.48, or 1.14%, to 11,100.54 -- after dipping below the 11,000 mark for the first time in two years during trading. The broader S&P 500 index lost 13.90 points, or 1.11%, to 1,239.49. The tech-heavy Nasdaq composite index fell 18.77 points, or 0.83%, to 2,239.08.

Adding to the market woes was another spike in oil prices. August crude oil futures on the NYMEX finished up $3.42 a barrel at $145.07, after posting all-time highs of $147.27 in morning trade. Talk of Israeli air force activity over Iraq, apparently using U.S. bases there prompted speculation that an attack on Iran's nuclear facilities may be imminent. These reports were subsequently denied, which likely took prices off their highs, says Action Economics. Meanwhile, prospects for a Brazilian oil workers strike, and potential for more rebel attacks on Nigerian oil facilities should keep oil prices on the boil for the near term, says Action Economics.

Among other stocks in the news Friday, Lehman Brothers (LEH) was down 2.87 to 14.43, after reporting in a 10-Q filing that its Level 3 assets at May 31, 2008, were $41.344 billion, vs. $41.979 billion at Nov. 30, 2007.

General Electric (GE) posts $0.54, vs. $0.54 a year ago, second quarter EPS from continuing operations on 11% revenue rise. It sees third quarter EPS from continuing operations of $0.50-$0.54 and reaffirms 2008 EPS from continuing operations guidance of $2.20-$2.30. Separately, GE inks an deal to sell its Japanese consumer finance business to Shinsei Bank in deal valued at $5.4 billion.

There was some more deal news Friday. InBev NV (INBVF.PK) boosted its takeover offer for Anheuser-Busch Companies (BUD) by $5 a share to $70 in an effort to seal a friendly deal with the iconic U.S. brewer, a person familiar with the matter said: WSJ.

Hercules (HPC) agreed to be acquired by Ashland (ASH) in a $3.3 billion deal. Terms: $18.60 cash and 0.093 ASH share for each HPC share. Total transaction value is $23.01 per HPC share, based on ASH's July 10 closing stock price and including $0.7 billion of net assumed debt.

There was more bad news on the inflation front Friday. U.S. import prices surged 2.6% in May with export prices up 1.0%, compared to gains of 2.6% and 0.4%, respectively in April (revised slightly higher from 2.3% and 0.3%, respectively). Petroleum import prices climbed another 7.4% on the month and are up 78.6% year-over-year (from 68.8% previously). Excluding petroleum, import prices rose 0.9%.

The U.S. trade deficit narrowed slightly to $59.8 billion in May from a revised -$60.5 billion in April (-$60.9 billion previously). Excluding petroleum, the deficit was $26.6 bln compared to April's -$26.7 bln. Imports were up only 0.3% on the month, and are up 12.5% year-over-year, while exports rose 0.9% and are up 17.8% year-over-year. The narrower than expected deficit is good news for the dollar, though it may not have much impact on the buck, overshadowed by the troubles in the financial markets, says Action Economics.

Major European indexes finished sharply lower Friday. In London, the FTSE 100 index fell 2.69% to 5,261.60. In Paris, the CAC 40 shed 3.09% to 4,100.64, while Germany's DAX index was down 2.41% to 6,153.30.

In Asia, Japan's Nikkei 225 closed 0.21% lower at 13,039.69, and Hong Kong's Hang Seng index climbed 1.66% to 22,184.55.

Treasury market

Treasuries fell sharply on reports that Federal Reserve Chairman Ben Bernanke opened the discount window to FRE and FNM, mitigating speculation of insolvency at the mortgage lenders. The 10-year note tumbled 36/32 to 99-17/32 for a yield of 3.93%, while the 30-year bond sank 53/32 to 97-24/32 for a yield of 4.51%. Losses also reflected profit taking ahead of the weekend following recent gains.

"Nerves remain raw in the bond market as the potential safety bid for Treasuries is set against the unwinding of that bid if the NY Times and Bloomberg are right that some form of the housing agencies will be rescued by the government," says Action Economics.

Looking ahead to next week, Bernanke will take center stage once again when he gives his semiannual monetary policy testimony before the Senate Banking Committee on Tuesday, along with an encore performance before the House Financial Services Committee on Wednesday. "Repeated calls by the Chairman and Treasury Secretary about the primacy of GSE reforms should get the rapt attention of Congress as U.S. officials attempt to keep Fannie Mae and Freddie Mac from imploding," says Action Economics.

The FOMC minutes for the June 24-25 meeting will also be revealed on Wednesday.

Before it's here, it's on the Bloomberg Terminal.