Many questions remain about the government's seizure of the mortgage giants Fannie Mae and Freddie Mac, but the plan has already passed its first test.
Stock markets around the world rallied on news of the U.S. Treasury's takeover, relieved that government control of the prodigal twins of the U.S. financial system would ensure that credit remain flowing in the troubled mortgage market.
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Benchmark stock indexes in Tokyo, Frankfurt, and London rose more than 3 percent. U.S. stock index futures were pointing to a higher opening this morning.
Equally as important was the positive reaction of China and Japan, the biggest buyers of Fannie and Freddie securities. Officials from both countries hailed the rescue.
"I think it will have a positive impact on the world economy as it eases worries over the U.S. economy through more stable financial markets in the United States," Bunmei Ibuki, the Finance Minister of Japan, told reporters, Reuters reported.
On Sunday, the Treasury announced plans to take over Fannie and Freddie, the two biggest buyers of U.S. mortgages, and put them in a conservatorship run by the Federal Housing Finance Agency. The C.E.O.'s of the two companies are stepping down.
By putting the full weight of the U.S. government behind the two, Treasury Secretary Hank Paulson is wagering that mortgage rates will ease and the nation's banking system will get enough breathing room to lend again. He's also gambling that removing the incentive of increasing shareholder value to focus more on stability and risk management will win a repaired Fannie and Freddie, and the U.S. economy, greater confidence at home and abroad.
"Our economy and our markets will not recover until the bulk of this housing correction is behind us," Paulson said on Sunday.
Whether the plan will succeed remains to be seen. But there are already clear losers.
Holders of common and preferred shares of Fannie and Freddie are some. Common shareholders aren't exactly wiped out, but they've come pretty close. The government is getting warrants for as much as 80 percent of the two companies' common shares. And dividends to preferred shareholders are being eliminated.
Taking one of the biggest hits is famed Legg Mason fund manager Bill Miller, who is Fannie's biggest investor. A number of regional banks are big Fannie and Freddie shareholders too—in particular Sovereign Bancorp.
Others, of course, have been betting against Fannie and Freddie for nearly a year, most famously hedge fund manager Bill Ackman.
And there will be a cost to taxpayers.
On CNBC, Paulson ducked the question, saying that Treasury had not done a specific analysis on it and noting that the answer will depend on how long it takes the housing market to recover.
William Poole, the former president of the Federal Reserve Bank of St. Louis, told Bloomberg Radio that he estimates that Treasury may need to cover as much as $300 billion in losses.
The federally chartered, shareholder-owned structure, with risks covered by taxpayers, is "an unacceptable situation," Poole told Bloomberg, saying that it is a "stopgap" that passes the ball to the next administration.
Poole is one of the few voices criticizing the bailout this morning. Yet how long will the euphoria last? The Bear Stearns rescue provided only a brief respite.
Now that the government has used its big guns, this bailout better hold off the credit storm for a while.
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