The Dow Jones industrials closed up 290 points and Bank of America and Citigroup stocks both rose more than 6 percent, showing a measure of confidence that the Treasury's takeover could help bolster the U.S. housing market -- though some of the enthusiasm for the plan was beginning to fizzle among investors by the end of the day.
"It definitely draws a line in the sand and should help credit conditions, but we still need the underpinnings of the housing market to show stability or improvement before we can say the credit crisis is behind us," Jack Ablin, chief investment officer at Harris Private Bank in Chicago, told Reuters.
At a press conference announcing the takeover Sunday, Treasury Secretary Henry Paulson said the housing correction poses the biggest risk to the U.S. economy.
"Our economy and our markets will not recover until the bulk of this housing correction is behind us," Paulson said.
The firms were placed under a "conservatorship" and new chief executives will replace ousted CEOs Dan Mudd of Fannie Mae and Dick Syron of Freddie Mac. The takeover will provide fresh capital to the firms, which have struggled to find backing in a market wary of the companies' abilities to continue to fund home-loans.
The government will provide up to $100 billion to help shore up each company. Together, the companies own or guarantee almost half of the $12 trillion of U.S. home mortgage debt.
Some observers immediately faulted the takeover plan's high costs.
"This is a shareholder bailout financed by the U.S. taxpayers," Armando Falcon Jr., formerly the chief regulator of Fannie Mae and Freddie Mac, told the Washington Post.
But Paulson stressed that the costs of the failure of the firms would be far more serious.
"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," he said in a televised statement.
The move was designed to keep the firms viable into 2009, but leaves the next administration and Congress to determine the long-term structure of the companies. The two firms are government-chartered, but shareholder-owned, and have lost $14 billion in the last year.
"The new Congress and the next administration must decide what role government in general, and these entities in particular, should play in the housing market," Paulson said Sunday. There is a consensus now that "they cannot continue in their current form," he added.
That leaves open the possibility of full nationalization, which would formalize the government's role in mortgage markets, or the possibility of splitting up and selling off the companies, reported Bloomberg News.
"This is the biggest event in my 21 years in the business," Arthur Frank, director and head of mortgage-backed securities research at Deutsche Bank, told Reuters of Paulson's decision.
President Bush said in a statement Sunday that the change is a temporary, "near term" intervention, but said that the failure of Fannie Mae and Freddie Mac posed "an unacceptable risk to the broader financial system and our economy."
"Americans should be confident that the actions taken today will strengthen our ability to weather the housing correction, and are critical to returning the economy to stronger sustained growth in the future," Bush said.
The takeover comes six months after the Fed provided $29 billion of financing to prevent the collapse of another finance giant, Bear Stearns & Cos.