Stock markets around the world soared yesterday as investors crossed their fingers that the US Government's rescue of Fannie Mae and Freddie Mac would finally mark the bottom of the financial crisis.
In New York, the Dow Jones Industrial Average closed up 2.6 per cent at 11,510.7, led by financial stocks. The US reaction to the effective nationalisation of the giant mortgage-finance companies followed rises in Asian and European stock markets.
The Dow Jones Euro Stoxx index rose 3.1 per cent and Japan's Nikkei 225 gained 3.4 per cent. In London, the FTSE 100 rose 3.9 per cent in the biggest jump for more than seven months before a technical glitch halted trading.
Financial shares led the rally in New York as Bank of America rose 7.8 per cent and Citigroup gained 6.6 per cent. But shares in Lehman Brothers fell 12.7 per cent on concerns that the beleaguered investment bank would be forced to sell its Neuberger Berman asset management arm for a bargain price.
Some of the fizz had also come out of the US market from earlier highs after concerns about technology stocks weighed shares down. In London, Barclays jumped 11.9 per cent, HBOS added 11.4 per cent, Royal Bank of Scotland gained 11.3 per cent and Lloyds TSB rose 11.1 per cent.
News of the rescue for Fannie and Freddie caused a sigh of relief across markets as investors bet that risk had been reduced in the financial system.
The cost of insuring against corporate default came down, with credit default swaps on the Markit iTraxx Europe index of 125 companies falling 10 basis points to 96.3. US Treasuries fell, pushing up the yield on 10-year notes as investors sought higher returns than that offered by the ultra-safe US government debt. UK government bond yields also rose on the news.
The federal government's move to seize control of the troubled companies, which together back about half the US's $12 trillion (£6.9 trillion) of residential mortgages, prompted relief that the US housing market might finally start to stabilise after more than a year of turmoil.
Big holders of Fannie and Freddie's debt, including overseas central banks, had become increasingly wary about the agency companies' financial condition. China and Japan, the two biggest buyers of Fannie and Freddie's bonds, praised Washington's rescue plan yesterday.
But some analysts said the euphoria could fade as investors realised that the agencies' woes were at least as much a symptom as a cause of the financial crisis.
The move is the third attempt by the US government to shore up confidence in Fannie and Freddie, whose ability to operate underpins the US housing market. In July, Hank Paulson, the US Treasury Secretary, tried to bolster the companies with a promise of new loans and a government injection of capital if either was pushed to the brink of disaster by mounting losses eating into their capital.
The effective nationalisation of the agencies is the step that Mr Paulson had been trying to avoid. He said the drastic measure was necessary to maintain confidence not just in the US but in the global financial system.
Jeremy Tigue, head of global equities at F&C Investments, said: "While the first two moves saw markets bounce in a knee-jerk reaction only to fall back again, this time I believe the change is more fundamental. Irrespective of any potential moves by governments in the UK, Spain, Ireland or elsewhere, we believe that, on balance, the US government intervention will prove to be a real turning point."
But the head of HSBC's North American business said the government takeover of Fannie and Freddie would not bring a quick improvement for mortgage holders in the US housing market. "There's no silver bullet for solving the US housing problem," Brendan McDonagh told a conference. "The immediate impact is going to be institutional and it will be much further down the line before we see a retail impact."
Under the US government's plan, the agencies' regulator will take over Fannie and Freddie under a "conservatorship", replacing their chief executives and wiping out their dividends. The US Treasury will receive $1bn of senior preferred stock in each company, but its equity stake could reach $100bn in each. The government's holding would be senior to existing common and preferred shares.
Fannie and Freddie's shares each lost about 80 per cent of their already battered values as investors bet that stockholders would be wiped out by the government's action. But the companies' debt soared on relief that their bonds were now guaranteed by the government. The yield premium on the agencies' debt against Treasury bonds narrowed by at least 20 basis points, reflecting the perceived reduction in risk.