If you heard this weekend that George Bush was stepping in to bail out Freddie Mac and Fannie Mae, you’d have been forgiven for wondering why the world’s most powerful man was involving himself in a trailer park row. However, the objects of the US government’s attention are in fact two companies that between them own about half of the country’s $12 trillion mortgage market - making them a hugely important plank in the US economy. In recent weeks their shares have been in freefall, forcing the US Treasury to announce a package of measures designed to bolster their finances – and to prevent any speculation that they could run out of cash.
The Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association (or Freddie Mac and Fannie Mae to their friends) are two huge shareholder-owned companies that provide finance to the US mortgage market. They don’t actually lend to homeowners directly, but they buy mortgages off lenders and package them up into investments that can be bought and sold - thus ensuring there’s plenty of liquidity in the market for people to buy houses. But when borrowers default on their mortgages, they have to foot the bill – and in the last few months, that bill has been going through the roof (so to speak).
To cover these big losses, the two companies need to raise extra funds – but the market seems unconvinced that they’ll be able to in the current climate (let’s face it, it would take a brave investor to back a massive mortgage company at the moment). With their share prices plummeting, the government has had to step in to save the day, announcing a plan that would expand the two companies’ access to credit and allow the Treasury to buy their shares (if necessary). Since these companies are so huge (they own or guarantee over $5trn in mortgages), this would represent a taxpayer-funded bail-out on an unprecedented scale.
As you’d expect, this hasn’t met with universal approval across the pond – some observers argue that the government shouldn’t be rescuing two private companies just because they couldn’t run themselves well enough to avoid huge losses. Fannie Mae actually used to be a state-owned company until the 1960s, and given that the Treasury has seen none of its profits since then, some feel it shouldn’t be propping up its losses now.
However the simple fact is that Freddie Mac and Fannie Mae are just too big and important to be allowed to fail. Not only would it cripple the US economy, it would also send shockwaves across the world, undermining confidence still further. So there was never really any doubt that Treasury Secretary Hank Paulson would eventually reach for his cheque book...