US mortgage giants taken under government control

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by Lin Freestone

The US government’s decision to take control of America’s two mortgage giants, Fannie Mae and Freddie Mac, will have long-reaching effects on the world’s economy. Investors anticipate that the largest bail-out in US history will prop up the country’s housing market and ultimately help to end the credit crunch.

Fannie Mae and Freddie Mac are quasi-public mortgage companies which own or guarantee almost half of the $12 trillion in outstanding home mortgage debt in the United States, and have lost billions of dollars during the US housing crash. The action by the US government is thought to be the largest financial bailout in US history.

Fannie Mae was set up by the US government in 1938 to help Americans finance their homes. It was privatised in 1968, and the US congress created Freddie Mac in 1970 to provide some competition.

Neither of the two government-sponsored enterprises lends money to homeowners directly. Instead, they buy mortgages from banks, packaging them into securities that are then sold for a fee to investors.

By selling their loans for cash, banks reduce their exposure to any one homeowner and can so turn around and lend even more, thereby providing more money at lower interest rates. Falling housing prices and a growing number of defaults have resulted in roughly $14bn in combined losses at the two companies in the past year.

The two government-sponsored enterprises are in conservatorship, meaning they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking.

One key element in the plan enables the Treasury and Federal Housing Finance Agency to purchase a new class of preferred stock in the firms that will ensure that each company maintains a positive net worth.

Although house prices in some parts of the US appear to be stabilising after more than two years of falls, analysts warned that the housing market is not yet ready to turn round. Mortgage delinquencies continue to set new records, promising more losses and future write-offs for banks and other mortgage lenders.