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Housing market not out of the woods — yet

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The government’s historic takeover of mortgage giants Fannie Mae and Freddie Mac is an important step in clearing up the mortgage mess that has cratered the housing market, panicked investors and sent the economy reeling. But homeowners, taxpayers and consumers are not out of the woods, yet.

The move is designed to tune up the sputtering twin engines of the mortgage market — Fannie and Freddie combined hold or guarantee more than $5 trillion in mortgages, or about half of all U.S. mortgages.

Fannie and Freddie's woes had begun to drive mortgage rates higher — the last thing the housing market needed — as investors began shying away from lending more money to the two giant companies.

The weekend takeover by the government helped allay the worst fears on Wall Street: that the mortgage companies might default on their obligations, touching off another earthquake in the financial markets. Stocks rallied around the world Monday on news of the takeover.

Stocks had been under pressure because of "Armageddon scenario" that now seems far less likely, said Paul McCulley, a portfolio manager at PIMCO, which has major holdings in mortgage-backed bonds. "And therefore they should rally and are rallying," he said.

By easing fears in the bond market, the government’s takeover should also bring mortgage rates back down again. That’s good news for anyone looking to buy a home or refinance a mortgage.

But while lower mortgage rates could spark some demand for houses, it won't do anything to slow the current wave of mortgage defaults and foreclosures that have left the market glutted with unsold homes.

Foreclosed properties often are sold at a discount by banks trying to unload them before prices fall further, putting more downward pressure on the market. Last week the Mortgage Bankers Association reported that a record 9 percent of American homeowners with mortgages were either behind on their payments or in foreclosure at the end of June.

While the Treasury’s action will help home buyers shopping for a mortgage, there are no immediate plans to provide additional help to the millions of homeowners with loans that they can’t afford.

So far efforts to provide direct government assistance to homeowners at risk of default have faced numerous roadblocks. The Hope Now Alliance, a voluntary program to induce lenders to work out more affordable loans has helped relatively few.

After more than a year of debate, Congress this summer passed a housing relief bill that was signed by President Bush but is expected to help only several hundred thousand of the more than two million homeowners at risk of losing their homes.

Much of the debate over the housing bill centered on the issue of whether the government should use tax dollars to “bail out”  homeowners who got in trouble — an approach the White House opposed. The bailout of Freddie and Fannie may help shift that debate to favor more aggressive action on behalf of homeowners.

In any case, until the tide of rising foreclosures turns, the overhang on the housing market will further delay its recovery.

“If (the government) takes over this debt, and they start working with distressed borrowers to help them extend terms and lower interest rates to keep people in those houses, then this is another big positive that could come out of this,” said Andrew Busch, an investment adviser with BMO Capital Markets. “Getting those additional homes off the market would help stabilize the housing market. That's where a huge bang for the buck could come in here — if somebody's smart enough to take advantage of this and start talking about it.”

Though the move will likely lower mortgage interest rates, it’s not clear how much impact the takeover will have on spurring bankers to make new loans. Without convincing evidence that house prices have bottomed, bankers will remain reluctant to lend money to someone who wants to buy a house that may be falling in value.

“On Main Street, we still have the reality of deflating home prices," said PIMCO's McCulley. "And this whole  process of getting affordable mortgage availability to stop the rot in the property market is going to have that to play out over time."

The takeover will add tens — perhaps hundreds — of billions of dollars to the national debt at a time when the government faces the looming Medicare and Social Security costs of the now-retiring baby boom.

Putting a price tag on the total cost to taxpayers is difficult. First, it’s not clear just how much cash Fannie and Freddie currently have on hand to weather coming losses; published reports suggest they have been slow to book the full impact of current mortgage losses.

“House prices are still falling," said Robert McKee, chief economist at the London-based advisory firm Independent Strategy Inc. “Losses are going to be made by the agencies and other mortgage lenders over the next year and a half. There's no way of escaping that. And even if they don't carry through foreclosure, they’re going to be in a much more difficult position. So I think we're talking about hundreds, maybe $300 billion worth of taxpayer money being exposed to the home mortgage market. Whether they'll get that back in the future remains to be seen."

Banks and investment funds holding mortgage-backed bonds will be helped by the government promise to buy up the worst of this toxic paper, which will help put a floor under the value of those holdings. But until falling housing prices and rising foreclosure rates begin to stabilize, it’s hard to know how much more banks will have to write down those losses.

There’s a flip side for banks, many of which have big holdings in Fannie Mae and Freddie Mac stock. In return for taking over Fannie and Freddie, the government took $1 billion in new stock. That could help offset some of the losses taxpayers will face in cleanup costs. But it also watered down the value of outstanding Fannie and Freddie stock held by banks, which will now have to write down those holdings.

As a result, the takeover "will shoot another hole in the severely battered hull of the financial system capital," according to Brian Bethune, chief financial economist at Global Insight.

To the extent that the housing market has dragged the U.S. economy into what many analysts are now describing as a recession, the takeover of Fannie and Freddie could mark an important turning point. But the worry is that the downturn in the economy has moved beyond the housing slump and developed a momentum of its own.

Friday’s employment report showed weakness in the job market spreading beyond the housing and construction industries. The global economy has also begun to lose momentum. Combined with recent strength in the dollar, that could put a crimp on the gains in exports that have partly offset the economic weakness in housing and financial sectors.

“Put simply, the economy is in recession and the changes unveiled today are not likely to alter the course of the business cycle," said Merrill Lynch economist David Rosenberg.