Last week, the two most talked about names were Fannie and Freddie and the news of their $200bn (€141bn) government rescue had a grip on the financial world. Markets reacted positively to the news, with the Dow Jones up 2.58 per cent and the FTSE 100 up 3.92 per cent.
The US government’s move was 25-times larger than the Northern Rock buy-out and probably the biggest since the
Marshall Plan. Though sizeable, the move was also widely expected. The government had implicitly backed Fannie and Freddie earlier this year, but despite their confidence-building measure, the share price of these companies continued to plummet, indicating that investors were simply not reassured.
Experts across the board were pleased with the government’s more decisive action, but were more reserved on their sentiment for short-term prospects. After just about every big headline in the crisis, investors have asked if this is finally the big hit that will signal the beginning of the end.
Keith Wade, chief economist at Schroders, called the move the most dramatic to date in the credit crisis saga and added that it became even more necessary when it became clear that interest rate cuts were ineffective.
He said: “In our view, this is an important step towards bringing recovery and ending the downward spiral that has gripped markets during the credit crunch. Continuing stress in the equity and credit markets has undermined monetary policy as a widening of financial market spreads has offset the benefit of lower policy rates.
“By bringing greater certainty about the value of mortgage-backed securities, confidence in bank balance sheets should rise, thus helping to reduce interbank borrowing costs. This, in turn, should result in lower mortgage rates, helping to support the housing market.”
While optimistic, he did caution that the downturn still had plenty of life in it, which would mean further house price falls, more unemployment and low confidence over the short term.
Jeremy Tigue, head of global equities at F&C Investments, tended to agree. He believed the move could be a real turning point in the bear market, but warned that there could be more difficulties ahead.
He said: “While the move is undoubtedly good news, the US economy looks set to remain fragile in the foreseeable future and companies will continue to find the environment a challenging one.
“From here on, attention and pressure is also likely to focus on other countries whose housing markets are behind the US, including the UK.“
It is an interesting point. If anything, the US market proved its resilience by beating the odds and continuing to grow last quarter. At the moment, it looks like Europe, and especially the UK, are the most vulnerable.
Guy Monson, chief investment officer and managing partner at Sarasin & Partners, blames this largely on monetary and economic policy.
He said: “A cheap dollar and sharply negative real rates in the US have cushioned the economy from the worst of the effects of falling real estate and collapsing residential construction numbers.
“While, in Europe, a strong currency coupled with interest rate rises has exacerbated a slowdown that should otherwise have been relatively mild.
Perhaps most telling is that European pension funds have been the slowest to react. Few appear poised to dump large quantities of equities, and many seem prepared to buy into highly illiquid assets as a way to beat their benchmarks. But, that said, they can only be happy about the Fannie and Freddie takeover.
Generally speaking, overall returns for European schemes have been lacklustre. Most of this was because of high equity allocations, especially in countries like Ireland. However, if equities are about to make a comeback, it could be a great year for equity-heavy schemes, unless their hits are so severe during the crunch that they will effectively break even. Also, do not forget that the hits have not stopped yet.
OUR VIEW
Two hundred billion dollars is an awful lot of money, but there seems to be general agreement that this was a necessary step to save the US and even the global economy. This magazine agrees, but it is the outcome that matters most.
Freddie and Fannie got away with lobbying the government for toothless regulations for years and this could be the end result. It is time the US government put some serious measures in place to protect homeowners from mortgages they cannot afford. This does not have to get in the way of competition, or a free market. Rules can be introduced that will keep the market vibrant and keep people in their homes.
Furthermore, this is not the first time that investors have reacted positively to an organisation’s salvation, only for the bludgeoning of equities to march on unabated. This one is far larger and could have a more direct effect, but a crisis of confidence remains. If investors stay nervous, we could have a lot longer to go.
Another question investors need to ask is: when can the credit crisis officially be declared over? Markets may recover, but general liquidity can be complicated to calculate. Confidence may also pick up, but it seems it would only take one bad headline to convince analysts that the crunch is alive and well. Cue Lehman Brothers.
