Stock markets soared around the world Monday and mortgage rates dropped precipitously as investors welcomed the U.S. Treasury's move to take responsibility for the debts of Fannie Mae and Freddie Mac.
The Dow Jones Industrial Average surged 289 points, or nearly 3 percent, to 11,511 on elation that the move may mark a turning point for battered housing and mortgage markets, where huge losses have weighed on banks and investors the world over and were spreading to other parts of the economy.
The relief was even more dramatic in overseas markets, which surged by as much as 4 percent on hopes the U.S. financial nightmare of the past year could be drawing to a close. In Europe, London's FTSE 100 blue-chip index jumped 3.9 percent, Paris' CAC 40 index rose 3.4 percent, and Frankfurt's DAX rose 2.2 percent.
Markets in Asia - where banks have widely invested in Fannie and Freddie debt - led the worldwide rally, with Japanese stocks up 3.4 percent, Hong Kong shares up 4.3 percent, and Sydney, Australia, shares up 3.9 percent
"The actions taken this past weekend will not cure all of the economy's ills or even guarantee improvement in home prices any time soon," said David Ader, investment strategist at RBS Greenwich Capital. "However, it should help to allay investors' worst-case fears, and be sufficient to prevent another massive leg down in housing demand unless the broader economy collapses."
Ashish Shah, an analyst at Lehman Brothers, said, "The strong support from Treasury might encourage overseas investors to return" to U.S. mortgage-debt markets after shying away in recent weeks. He estimated that mortgage rates will decline by nearly a half percentage point as investors rush back into mortgage securities.
Mortgage rates fell sharply Monday on the news, with the rate on 30-year fixed loans down to 6.08 percent from 6.26 percent a week ago, according to Bankrate.com.
"By lowering mortgage rates and easing some of the lending standards, Treasury should alleviate some pressure on the housing market," and boost U.S. economic growth, Mr. Shah said. But he noted that at this point credit problems are so entrenched in the U.S. that Treasury is "removing a significant tail wind rather than solving all the market's problems."
In a notable exception to Monday's broad stock rally, the one-time blue-chip shares of Fannie and Freddie both fell to less than $1, reflecting their much-diminished value after Treasury's acquisition of an 80 percent stake in the companies.
Fannie shares fell as much as 86 percent in New York Stock Exchange composite trading to their lowest level since 1985. Freddie's common shares dropped 83 percent to their lowest point since they began trading 20 years ago.
"The shareholders are being left out in the cold," said Brian Bethune, chief U.S. economist at Global Insight. "While the takeover is bad news for existing shareholders, it will be good news for American households who are either looking to purchase a home for the first time, or refinance their existing mortgage."
Consumers will benefit from Treasury's making it easier for Fannie and Freddie to finance their gigantic debts, Mr. Bethune said, with mortgage rates possibly dropping below 6 percent by the end of the year.
"The prospective decline in mortgage rates should provide a needed shot in the arm to the U.S. housing market, as it would provide another boost to affordability beyond the sharp declines in prices that we have seen in the past two years," he said.
Yet at the same time, the huge losses for Fannie and Freddie stockholders "will shoot another hole in the severely battered hull of financial system capital," and it is not clear what the net effect on financial markets will be, he said.
About a third of Fannie and Freddie's mortgage debt is held by U.S. banks, another third by foreign investors and the final third is held by the enterprises themselves, according to Lehman estimates. Many U.S. banks and pension funds also own Fannie and Freddie stock and will be hit hard by the Treasury's takeover.
Sovereign Bancorp Inc., the second-largest savings and loan, owns $629 million of Fannie and Freddie stock; Wells Fargo & Co., owns $480 million; and many smaller banks have devoted large shares of their capital to the stock investments.
Some smaller banks are so heavily invested in Fannie and Freddie that they risk being shut down in the face of huge losses. The Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision have offered to work with those lenders on "capital restoration plans."
Joshua Rosner, managing director at Graham Fisher & Co., said the markets' "jubilation" over the Treasury plan is "insanity" because the bailout could have been avoided with stricter regulation of Fannie and Freddie.
"It was generally the right thing to do, but that is different from it being positive for capital markets," he said. "The markets are rallying aggressively, many banks who will take losses on [Fannie and Freddie] preferred and equity securities are rallying as well. Perhaps there is an assumption that the government will not allow anyone to fail.
"This euphoria will not be lasting," he predicted.