NEW YORK (CNNMoney.com) -- Shares of Freddie Mac and Fannie Mae saw early gains evaporate Monday as investors showed they were not convinced that government support will be enough to prop up the battered mortgage giants.
The continued weakness in share prices, which hovered near 17-year lows, is troubling because the two firms are crucial sources of home loan funding and key to any recovery of the economy.
The government announced steps Sunday to make funds available to the firms if necessary in a bid to reverse the slide in confidence this year. While experts applauded the Treasury Department and Federal Reserve for stepping in, they said the success of the efforts will ultimately be measured by market reaction.
Shortly after the U.S. markets opened, shares of Fannie (FNM, Fortune 500) jumped as much as 32%, while shares of Freddie (FRE, Fortune 500) jumped 26% higher.
But within the first half-hour of trading, the shares fell briefly into negative territory before rebounding to show only a narrow gain from Friday's close. By midday they had fallen into negative territory once again, with Freddie shares tumbling 10%.
Even with those early gains, shares of the two companies had recovered only a fraction of the declines they suffered in trading last week.
Things were a touch better in credit markets, as Freddie received good prices on $3 billion in corporate debt it sold through auction early Monday morning.
Three-month bonds sold at a slightly lower interest rate than Freddie's previous auction a week earlier, while the six-month bond sold for only a narrowly higher price, according to wire service reports. That suggests that investors are more confident about the near term outlook for the firms than the long-term.
Treasury Secretary Henry Paulson said Sunday the Bush administration plans to ask Congress to pass legislation that would temporarily extend lines of credit from Treasury to the mortgage providers. The firms now have authority to borrow up to $2.25 billion each from Treasury. Treasury did not disclose how much of an increase in that credit line it was seeking. The New York Times reported Monday that some officials briefed on the plan said it could raise the limit to as much as $300 billion.
Paulson also proposed that Treasury be given authority to buy equity in the companies, although a wire service report Monday morning said that Treasury did not expect to need to use the authority, that it was only proposed as a "back-stop" to be used on an "as-needed" basis.
In addition, the Federal Reserve announced that the Federal Reserve Bank of New York had been granted authority to lend to Fannie and Freddie should such lending prove necessary. The Fed has traditionally only lent money directly to commercial banks, but since it helped engineer a purchase of Bear Stearns in March, it has allowed Wall Street firms to also tap into that source of funds, known as the discount window.
"This plan meets the policy requirements for a rescue," said Jaret Seiberg, a financial services analyst for the Stanford Group, a Washington research firm, in a note Monday morning. "It provides emergency liquidity measures and establishes a mechanism for injecting capital into the enterprises if needed."
Both companies said that they have adequate capital and that it is possible they might not need to turn to the Fed or Treasury for funds. The Office of Federal Housing Enterprise Oversight, the federal regulator that oversees the firms, also said on Sunday that the companies have enough capital.
Seiberg said it's too soon to tell if the plans announced Sunday are enough to see Fannie and Freddie through the current crisis.
"Ultimately, the success or failure of this plan rests with the market," he said.
University of Central Florida economist Sean Snaith said he agrees that the actions by Treasury and the Fed were prompted by market concerns more than any imminent problem the firms might have continuing normal operations.
"Using the stock market as a barometer is difficult to do in a case like this," Snaith said. "This crisis is essentially a crisis of confidence, and that confidence takes some time to restore."
The two firms, which were set up by the government, own or back about $5 trillion worth of home debt - half the mortgage debt in the country. They have suffered about $12 billion in losses between them since last summer.
Since the crisis in credit markets last year, they have become virtually the only source of funding for banks and other home lenders looking to make home loans. Their ability to do so is crucial to the recovery of the battered home market and the broader U.S. economy.
Despite their government-sponsored status, they are owned by shareholders, and those investors drove shares down by nearly half last week on concerns that they would not be able to raise the capital they need to cover future losses. The declining share price made it more difficult and expensive to raise that capital. Fear was rampant on Wall Street last week that a government bailout would leave shareholders' stake worthless.
Sen. Christopher Dodd, chairman of the Senate Banking Committee, told CNNMoney.com on Monday that he is confident Fannie and Freddie are sound, and he praised the actions by Treasury and the Fed Sunday.
"It looks as least that first blush that these ideas that are being floated are having the desired effect and that is to calm things down here and to restore some confidence that the people need to have in these [firms]," he said.
But he vowed to have hearings this week on both the plans to help Fannie and Freddie, as well as on the failure of California bank IndyMac, which was taken over by the Federal Deposit Insurance Corp. on Friday evening in the largest bank failure since 1988. IndyMac had been one of the leading lenders making home loans in which borrowers were not required to provide documentation of their income.
-- CNNMoney.com staff writer Aaron Smith contributed to this report
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[Via Home Mortgage Rates and Real Estate News]
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