Page last updated at 12:24 GMT, Monday, 8 September 2008 13:24 UK
US rescues giant mortgage lenders

By Simon Atkinson
Business reporter, BBC News

Fannie Mae building
Fannie Mae and Freddie Mac are central to the US housing market

The rescue of Fannie Mae and Freddie Mac is the biggest corporate rescue in history - and dwarfs the UK government's bail-out of Northern Rock last year.

The Rock was taken into government hands after it was nationalised, with loans worth 100bn on its balance sheet, several months after the dramatic pictures of queues forming outside its branches forced the Treasury to guarantee its deposits.

But the size of that rescue is miniscule compared with the troubles faced by Freddie Mac and Fannie Mae.

The two firms:
Buy mortgages from approved lenders and then sell them on to investors - rather than lending directly to borrowers
Guarantee or own about half of the $12 trillion US mortgage market
Are relied on by almost all US mortgage lenders
Are looked to for funds to meet consumer demand for mortgages
Link mortgage lenders with investors - keeping the supply of money widely available and at a lower cost
Have no direct UK equivalent

Together, the two firms own or guarantee about $5.3 trillion (2.7 trillion) worth of home loans - more than half the outstanding mortgages in the US.

That is about 25 times as big as the Rock's obligations, and twice the size of the UK economy.

Worries about their financial health initially prompted the US government to promise that taxpayers will prop them up.

Now the companies have been taken under government control because they, according to President Bush, pose "an unacceptable risk" to the economy.

It will cost the US taxpayer at least $200bn to rebuild their capital - and the cost could be a lot higher if the US housing market continues to plummet.

'Implode' risk

There will be no queues outside branches of Freddie Mac or Fannie Mae - quite simply because there are not any.

In fact, despite them guaranteeing or owning just under half of the entire US mortgage market, you cannot actually get a home loan from either firm.

But while they are invisible to the average borrower, the two firms are highly influential institutions and are key to the US housing market.

As one US Treasury official puts it, the two firms are "way too intertwined with everyone in the world" to fail.

Banks around the world are highly exposed to the two companies.

And, given the febrile state of markets across the world, it had become dangerous for doubts to persist about whether they were viable and would be able to keep up the payments on their massive liabilities, said the BBC's business editor Robert Peston.

Accounting flaws

While the housing market turmoil has caused the firms great damage, its problems appear to be partly be to do with the way it managed its accounts - which had the effect of overstating its capital resources and financial stability.

The New York Times reported that Freddie Mac had pushed losses it had already incurred into the fourth quarter of 2008 - meaning that it would not have to be revealed until next year.

Fannie Mae had done something similar, but to a lesser extent, the paper said, adding that neither firm had necessarily breached accounting rules.

Both firms had also factored in tax benefits on profits that they were yet to see - credits which are worthless until profits are actually made - something neither has managed in the past year.

It was investigations by the Federal authorities into these irregularities that helped prompt the government to act.

The guarantees given by the US government were no longer enough.

Affordability argument

Freddie Mac and Fannie Mae had profited from the US housing boom.

As the value of US homes soared, the importance of these two institutions grew in allowing people to purchase property.

The two firms do not lend directly to homebuyers, instead buying mortgage debt from approved lenders such as banks, and then selling it on to investors.

I have lost both faith and trust in banks
Keith Ridgers, Cobham

Almost all US mortgage lenders, from huge financial institutions such as Citigroup to small, local banks, rely on Fannie Mae and Freddie Mac, looking to them for the funds they need to meet consumer demand for mortgages.

The two firms argue that they make home ownership more affordable, lowering the interest rates on the 30-year mortgages that they guarantee.

But their peculiar status has left them in a grey area between being government owned and private sector, with potential risks to the taxpayer should they need bailing out.

Close links

The rescue at Freddie Mac and Fannie Mae contrast with the recent collapse of California-based IndyMac Bank - the second-largest financial institution to fail in US history, regulators say.

IndyMac had been struggling to raise funds and stay in business in one of the states worst hit by the US housing market slump.

Without similar close links to government it could not weather the storm, and went into administration.

But it is clear that Washington wants to keep Freddie Mac and Fannie Mae alive and kicking, not least so that they can play a key role in reinvigorating the housing market.

But there is a strong consensus that the price of not intervening would be far worse.

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