China and Japan hail U.S. mortgage rescue

(We had better not get into a shooting war with China, Japan or Saudi Arabia for that matter. What a situation to be in.)

By Yoko Nishikawa and Mike Dolan

TOKYO/LONDON (Reuters) - China and Japan, the biggest buyers of Freddie Mac and Fannie Mae bonds, on Monday praised Washington for rescuing the ailing mortgage giants, but investors said the bailout had not ended global credit market misery.

As battered financial stocks rallied and investors sold safe-haven bonds, analysts cautioned that the plan announced on Sunday was more a sign of the perilous state of the global financial system than of an imminent recovery

"We find it difficult to see how it is bullish that the heavy hand of government is needed to such an extent," Merrill Lynch economist David Rosenberg said.

"In our view, the takeover of Fannie and Freddie is actually a testament to how broken the financial system is at this time."

China and Japan, the biggest and the second-biggest holders of the Fannie and Freddie bonds, welcomed the bailout.

"I think it will have a positive impact on the world economy as it eases worries over the U.S. economy through more stable financial markets in the United States," Japanese Finance Minister Bunmei Ibuki told reporters on Monday.

Freddie (FRE.N) and Fannie (FNM.N) bond holders are the most likely long-term beneficiaries of the U.S. government's move which puts existing shareholders last in line in any claims.

Bonds from the agencies -- around $180 billion of which mature by the end of the year, according to Reuters data -- were trading a full percentage point above U.S. Treasuries on Friday.

On Monday the bonds they were effectively as safe as U.S. government debt, but bond dealers said none had changed hands during morning trade in London.

"We think a compression is likely," Goldman Sachs said in a note to clients, of the spread over Treasuries.

The price of U.S. government bonds sank on Monday and yields jumped as the bailout removed some of the fear that had crept back into markets in recent weeks and had fuelled a 'safe-haven' bid to bonds

The cost of insuring against the risk of a U.S. government default on its debt rose, with credit default swaps (CDS) widening on five-year and 10-year Treasury debt.

U.S. stocks futures and Asian and European share markets soared after the news of the takeover that could become the costliest U.S. bailout ever. UBS (UBSN.VX) and Mizuho Financial (8411.T), two casualties of the year-long credit crisis, jumped 10 percent and 11 percent respectively, leading rallies among banks in Europe and Asia.

Financial firms have posted over $500 billion in credit losses and write-downs since credit markets seized up a year ago after defaults on U.S. home loans.

"We expect the action would lead to stabilize the U.S. MBS (Mortgage-Backed Securities) market, financial market and the international financial market," Bank of Japan Governor Masaaki Shirakawa told reporters in Basel on the sidelines of the Bank of International Settlements meeting in Switzerland.

According to U.S. Treasury data, Japan is the second-biggest holder of U.S. agency debt with $229 billion, after China with $376 billion as of mid-2007.

"Different people may have different responses. From my point of view this is positive." China's central bank governor Zhou Xiaochuan said.

PAULSON TO EXPLAIN TO G7

U.S. Treasury Secretary Henry Paulson said in an interview with U.S. radio broadcast on Monday that the plan had been structured in a way to protect U.S. taxpayers.

He also told WAMU radio, monitored via the Internet in London, that the move had been taken after the Treasury had found "major structural flaws" in the two agencies.

Paulson was due to explain the details of the rescue to his Group of Seven counterparts later on Monday, Japan's Ibuki said.

By rushing to the rescue of institutions that own or guarantee almost half of the $12 trillion in U.S. home mortgage debt, Washington has removed one source of anxiety that has plagued markets and helped push Japan, Europe and United States toward recession.

But investors and analysts were quick to point out that a risk of collapse of the lenders and a U.S. housing market meltdown were not the only threats looming for the world economy.

"You've got to try and separate this GSE deal and what's going on with the banks (shares) from what's going on in the economy. That's not changed because of what has happened with Fannie Mae and Freddie Mac," said Kenneth Broux, financial markets economist at Lloyds TSB in London.

The cost of protection against default in U.S. Treasury debt edged up and the dollar gained against the yen , but lost to the euro and several other currencies.

The Treasury took $1 billion in preferred senior stock in each company, but its equity stake could reach as much as $100 billion in each.

Freddie Mac shares tumbled more than 50 percent in Frankfurt (FRE.F) when trading began on Monday. Freddie and Fannie, which serve a government mission to support housing, were put in a conservatorship that allows their stock to keep trading but puts common shareholders last in line in any claims.

Paulson had hatched a plan in early July to shore up the struggling firms with a promise of fresh loans and a government injection of capital if either company was pushed to the brink of collapse.

Fannie Mae and Freddie Mac were so large that "a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Paulson said.

But talks on an aid package ended abruptly in the past few days and policymakers decided to seize the firms, industry sources with knowledge of the events said.

"We were given an ultimatum -- do you want to die slowly or do you want to die quickly?" one company source said.

(Reporting by Yoko Nishikawa in Tokyo, Tamora Vidallet and Natsuko Waki in Basel, Patrick Rucker in Washington, Kevin Plumberg in Hong Kong, Rob Taylor in Canberra, Vidya Ranganathan in Singapore, Jamie McGeever in London; Writing by Tomasz Janowski)