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Back to business at Freddie Mac

Although shares continued to waffle, there was high demand for Freddie Mac's weekly bond sale Monday.

By Katie Benner, writer-reporter
Last Updated: July 14, 2008: 11:08 AM EDT

NEW YORK (Fortune) -- There was unusually high demand for Freddie Mac bonds Monday, with its routine debt auction oversubscribed; but its shares continued to waffle as investors digested the government's weekend efforts to prop up the troubled company.

Freddie Mac (FRE, Fortune 500) sold $2 billion worth of three-month bills at an interest rate of 2.309%, according to Reuters. That interest rate is lower than the 2.323% it paid to auction off three-month debt on July 7. The fact that investors are asking for a slightly lower interest rate would indicate at first blush that the market thinks that Freddie debt is less risky (bond investors ask for higher interest rates to compensate for taking on added risk).

However, investors demanded slightly higher interest rates for six-month Freddie Mac debt. According to Reuters, the $1 billion worth of notes sold at 2.496%, up from 2.489% that six-month debt fetched at the July seventh auction.

"The auction itself was very healthy and what stands out is that there were more people bidding relative to the amount of debt available," says Zack Pandl, a Lehman Bros. economist with a specialty in fixed income. The bid-to-cover ratio, which measures demand, was more than 50% above the average number of bidders over the past three months, according to Bloomberg.

Investors were eager to buy the company's debt is in large part due to a plan implemented by the Federal Reserve and the Treasury this weekend to restore faith in the solvency of Freddie Mac and its sister company Fannie Mae, says Michael Cheah, a fixed income portfolio manager with AIG SunAmerica.

"The package that has been put in place allows these two companies to borrow even more money from the government, so the immediate question of liquidity is no longer an issue," says Cheah. "Lenders now have no fear over whether Freddie will pay its bonds in the future."

These debt auctions are a weekly routine for Freddie Mac, a company that regularly borrows money in the form of short bonds in order to finance its day-to-day operations. Similarly, Fannie Mae (FNM, Fortune 500) also sells short-term bills. Its upcoming auction this Wednesday of $2 billion in three-month bills and $1 billion in six-month bills July 16 will be widely watched to see what price investors will demand to loan money to the company.

However, the stock rose, fell, then rose again after the results were posted, showing that equity investors were not sure how to take the government's liquidity measures. "The question is whether there is anything in the government plan that actually leads investors to believe that Freddie and Fannie are in a better position to make money and grow earnings now than they were before," says Cheah. "And now that the government can come in and buy shares, no one knows the terms or how much it will dilute value for existing shareholders."

Sunday, the government revealed a broad plan to prop up Freddie Mac and Fannie Mae after a brutal week of liquidity worries drove the stocks down by more than 40%. The Bush administration plans to ask Congress to enact legislation to temporarily increase the line of credit that the companies have with the Treasury, as well as buy company stock.

Under the plan, the Federal Reserve would increase its powers of supervision over both companies and open its discount lending window to the companies. This helps guarantee that the firms will be able to borrow money at the low interest it needs to keep its businesses from failure. The discount window was once reserved for commercial lenders, but the Fed granted the same access to investment banks after Bear Stearns collapsed.

The two government-sponsored companies play a crucial role in the US economy; and officials have been looking to expand the powers of Fannie and Freddie to help put an end to the ongoing mortgage meltdown. To top of page

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