Fears about the worsening health of the two largest U.S. mortgage finance companies slammed global stocks and the dollar on Friday spurred by a report of a possible government takeover that could trim or eliminate the value of its common stock.
The effort to bolster the housing finance giants Fannie Mae and Freddie Mac, publicly traded and government sponsored entities formed years ago to promote home ownership, is the latest chapter in a U.S. housing finance crisis that began more than a year ago as mortgage failures soared.
Wall Street opened weak and extended its losses after U.S. Treasury Secretary Henry Paulson said his department's chief aim is to back Fannie Mae and Freddie Mac in their "current form" - comments investors said failed to soothe their concerns.
Paulson's comments suggested the government has not been able to stem a yearlong credit crisis that has sapped global markets and economic growth.
The benchmark 10-year U.S. Treasury note fell 25/32 to yield 3.89 percent. The 30-year U.S. Treasury bond fell 36/32 to yield at 4.48 percent.
The blue-chip Dow marked its first fall below 11,000 for the first time since July 2006, and the leading index for the top 300 European shares closed at three-year lows as fears of massive capital infusions for Fannie and Freddie rattled investors.
"The bottom line is that we're in the middle of a financial Tsunami. This is a storm the likes of which this country hasn't seen," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.
A bailout would likely wipe out some or all of the common stock of the two government-sponsored entities, which hold more than $5 trillion (2.5 trillion pounds) in mortgage assets and were set up to finance home ownership.
Shares of the two companies - pillars of the U.S. property market and economy - have tumbled to a fraction of their value just weeks ago, but their bonds soared as investors bet the government would back their debt. They fell to 50 percent of their day-earlier level early Friday then cut their losses in half after Paulson downplayed the likelihood of any near-term bailout.
Investors fear the impact of a protracted financial crisis on the already weak U.S. economy and markets, in particular, for U.S. debt, which relies on the faith of foreign investors. The U.S. stock market, bonds and the dollar all fell, with equities hit the hardest.
Paulson's statement that the mortgage companies would stay "in current form" was key to understanding his message, Bill Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida. Paulson was responding to speculation that either one or both of the companies might enter conservatorship.
"That suggests that they want to avoid a conservator entity for these GSEs. That suggests avoiding a bailout, at least initially," Sullivan said. "There is not an imminent bailout on horizon," he said.
At 6 p.m. British time, the Dow Jones industrial average was down237.34 points, or 2.11 percent, at 10,991.68. The Standard & Poor's 500 Index was down 26.79 points, or 2.14 percent, at 1,226.60. The Nasdaq Composite Index was down 52.96 points, or 2.35 percent, at 2,204.89.
The FTSEurofirst 300 index closed down 2.6 percent at 1,126.39 points - its lowest close since June 9, 2005, according to Reuters data.
Euro zone and U.S. government bonds briefly pared losses Paulson's statement gave no hints of a bailout for Fannie and Freddie, whose shares plunged more than 40 percent each.
Those shares began to tumble in pre-market trade after The New York Times reported the U.S. government was considering a takeover - a move that would guarantee the mortgages the two lenders hold, but that could leave shareholders with nothing.
European shares initially rose on the report, with investors relieved that Washington looked ready to step in to save the two massive lenders. But shares later fell sharply to three-year lows after Wall Street opened lower.
