US stocks rebound on credit hopes (FT.com)

US stocks rebounded as financial shares gained ground on hopes that Fannie Mae (NYSE:FNM) and Freddie Mac - the giant government-sponsored mortgage companies - would help stabilise credit markets.

After falling 2.7 per cent on Friday, the S&P 500 Index rose 2.4 per cent on Monday, the day before Federal Reserve policymakers were set to meet for the first time since the current round of market turbulence began.

Fannie and Freddie soared 10.4 per cent and 7.7 per cent, respectively, as investors bet that their funding advantages would help them profit from the turmoil. Because of their links to the government, Fannie and Freddie are able to raise money more cheaply than other companies that buy mortgages, either to hold as investments or to package as securities for investors.

Investors were also reacting to speculation that the companies would be given greater opportunity to buy mortgages by their regulator, the Office of Federal Housing Enterprise Oversight.

Ofheo, Fannie and Freddie all declined to comment on whether the companies had requested a review of their mortgage portfolio caps. However, regulators were understood to be reviewing the cap imposed on Fannie in 2006 after an investigation found flaws in its accounting, corporate governance and risk management practices.

The rumour that the caps on their holdings could be lifted were fuelled partly by comments made by Mike Perry, chief executive of Indymac, a large home lender, about the willingness of lawmakers, and Fannie and Freddie, to help the lending industry. He quoted Fannie's chairman as saying that it was "prepared to step up and help the industry".

TJ Marta, fixed-income strategist at RBC Capital Markets, said a lifting of the cap would be "a more precise and effective liquidity injection" than a rate cut by the Fed.

Freddie in April had pledged to back as much as $20bn in refinancing of distressed subprime mortgage loans. That plan was intended to assure lenders that there would be financing available if they shifted homeowners from high-risk mortgages to traditional ones.

Distress in the US mortgage market has made investors more reluctant to buy debt of various kinds, creating funding difficulties for buy-out groups and other risky borrowers that raise funds in the leveraged loan markets in US and Europe.

According to Standard & Poor's Leveraged Commentary Data, an industry newsletter, the price of these corporate loans in the secondary market has slumped in recent weeks, implying sharply higher borrowing costs on new loans.

Last Friday, for example, the average asking price for a loan in Europe was about 97.72 per cent of its face value - and the lowest level ever seen. Two weeks ago European loans were trading at 99.52 per cent.

In mid-July, they were trading at 100.08 per cent. In the US, loans are now trading at 95.23 per cent of face value, having exhibited an even more dramatic fall in recent weeks.

These price movements will probably increase the pressure on investment banks that are struggling to sell large volumes of loans they have underwritten for private-equity deals.

Analysts estimate that banks have underwritten $300bn worth of loans to finance deals that have yet to be completed. The loan-price swings could also create fresh losses for some investors, such as hedge funds.