Markets Surge, But Shares in Loan Giants Slide As Doubts Set in

A frenetic day on global financial markets saw stocks rally but shares in Freddie Mac and Fannie Mae plunge, as investors digested the full implications of the latest American plan to end the year-long credit crunch.

Fears that the public ownership, or "conservatorship", of the two US mortgage giants might provide only a temporary boost for the US housing market, and the world's financial system more generally, meant that an initial 300-point gain on Wall Street's main share index was pared back later in the day.

Dealers in London were frustrated as the London Stock Exchange's computerized trading system froze barely an hour into the day. It had put on 200 points, or almost 4%. Angry traders said the shutdown was an embarrassment for London and the exchange, which is under huge pressure from rivals for the lucrative earnings in the world's third-largest stock market.

By lunchtime in New York the Dow Jones industrial average was up 180 points, or 1.6%, at around 11,400. The dollar strengthened against the pound to around $1.748 as it rose to its highest level in nearly a year.

The US treasury secretary, Hank Paulson, said that the quasi-nationalization of the two US mortgage giants, announced on Sunday, was needed because the companies were running a "flawed business model" that should never have been allowed.

The mortgage giants had to be bailed out because of their importance to the mortgage market and the financial system, Paulson said, adding that the government's plan made sure that taxpayers were protected, but that shareholders would not be insulated from losses. As he spoke shares in Freddie and Fannie shed more than 80% of their value on Friday to trade at just over $1 a share.

Analysts said the Freddie and Fannie bailout - the largest in US history - was unlikely to mark the beginning of the end of the global credit crunch.

"Our view is that, rather than marking the turning point that assures an economic recovery, the support that has had to be provided to the two US mortgage giants over the weekend simply underlines the severity of the ongoing credit crisis," said Julian Jessop at Capital Economics in London. "The bailout will help to avoid the worst case scenario of a complete financial meltdown, but the outlook for the housing market and the wider economy remains grim."

News emerged yesterday that the departing chief executives of Freddie Mac and Fannie Mae, Richard Syron and Daniel Mudd, will take combined severance pay of $23m. George Bush said he did not view the nationalization of the troubled lenders as a "bailout", but a "stabilization" to calm markets after the sell-off in shares seen last week.

A White House spokeswoman added that Bush had been warning Congress for years about the danger posed by the two mortgage institutions and had been calling for a strong independent regulator.

Analysts also said figures from the Mortgage Bankers Association on Friday had shown that the embattled US housing market was in much worse shape than thought, giving added urgency to the need for action. The largest US savings and loan business, Washington Mutual, was put under special regulatory supervision and ousted its chief executive, Kerry Killinger, following rising losses related to the US sub-prime mortgage market. Washington Mutual lost $6.3bn in the last three quarters and has said losses in its mortgage portfolio could approach $19bn by 2011.

Some analysts speculated that Fannie and Freddie were likely to be under state control for at least two years.

Barack Obama and John McCain grudgingly welcomed the treasury takeover of the mortgage companies as a necessary short-term intervention. But Republicans favor handing their portion of the mortgage market to privatized companies. The Democrats want to retain a public role, arguing that Fannie Mae and Freddie Mac provide mortgages for people who would not otherwise be able to afford them.