Government's Rescue Plan Leaves Unresolved Problems

July 14, 2008— -- For the second time in five months, top government officials have been so concerned about the potential for panic in the financial markets, that they took emergency action over the weekend.

After the government's announcement Sunday of a plan to offer more support to troubled mortgage giants Fannie Mae and Freddie Mac, investors waited with raw nerves and baited breath to see if the plan would work.

Today, a nervous day of trading began with a burst of optimism.

"We have a little bit of a positive response to what was happening over the weekend," said David Henderson, president of Raven Securities.

Over the weekend, government officials scrambled to restore confidence in Fannie Mae and Freddie Mac with an extraordinary three-part plan.

Treasury Secretary Henry Paulson said Sunday the plan would: give Fannie and Freddie an almost unlimited line of credit from the government; give the Treasury authority to use taxpayer money to buy Fannie and Freddie stock; and give the Fed a hand in regulating the two mortgage giants.

"It was a very important deal," said Stu Hoffman, chief economist at PNC Financial Services Group. "No doubt it was a signature event."

Within minutes of the opening bell today, the Dow had jumped 130 points, and shares of Fannie had shot up 25 percent -- Freddie more than 20 percent. But some say the euphoria was short-lived, because investors soon turned their focus to unresolved problems the plan did not address.

"It doesn't bring oil prices down, it doesn't improve consumer confidence," Hoffman said. "It's not necessarily going to help housing prices. Unfortunately, the U.S. economy has other demons bothering it right now."

Government officials defended the plan as a critical move to reinstate confidence in a market consumed by runaway fear. Sen. Christopher Dodd, D-Conn., went to great lengths to make sure the plan was not characterized as a bailout.

"There has been absolutely no bailout here," Dodd said. "Those words have absolutely no application. What we're talking about is shoring up the confidence people need to have in Fannie and Freddie."

Dodd described Paulson's plan as the best choice among the alternatives, saying that, without it, the economic damage would have been worse.

"What's the alternative? To let fear rule? To take over and end up with runs?" Dodd said. "Then, that process creates far many more problems than, frankly, we like to have. This is the right step to be taking. It's practical. It's pragmatic and it's necessary."

By the end of the day, prices were down again, with shares of Fannie down 5 percent and Freddie stock down 8 percent. The gains prompted by the government's plan had already evaporated.

Though the Dow closed down 45 points, analysts think of it as a good day, since they know it could have been much worse.

A major bullet was dodged, but as one analyst said, banks and airlines are expected to report in the red next week, leaving a sense of foreboding in the air.