Fannie and Freddie face overseas confidence crisis

By Lynn Adler

NEW YORK (Reuters) - An extraordinary Treasury capital infusion may be needed to restore faltering foreign demand for debt issued by Fannie Mae and Freddie Mac, the two top home funding sources that the government is willing to rescue to save the housing market.

The companies rely heavily on overseas investment, often up to two-thirds of each new multibillion-dollar note offering, to help pare funding costs and keep mortgage rates low.

But foreign central banks have dumped nearly $11 billion (5.9 billion pounds) from their record holdings of this debt in four weeks, to $975 billion (522 billion pounds), and won't return in force before it's clear if -- and how -- the government will back Fannie and Freddie, some analysts say.

President Bush has already approved the means by which Treasury and the Federal Reserve could bolster these two companies, which both reported greater-than-expected quarterly losses and steps to beef up capital.

Fannie (FNM.N) and Freddie (FRE.N) said they aren't seeking that support and Treasury Secretary Paulson said he isn't offering.

The bonds these companies issue in the $4.5 trillion agency MBS market are near or worse than the weakest levels, set in March before the government engineered the sale of failing Bear Stearns to JPMorgan.

"People are concerned about whether there's a bailout that's going to be coming from the U.S., so it would be logical to see foreign investors pull out of agency paper," said Kevin Chau, forex analyst at IDEAglobal in New York.

"They don't know whether the U.S. is going to be committed to supporting the GSEs, and if they are going to support them, by what methods are they going to support them."