NEWS | Wednesday, 10 September 2008

US rescues Freddie Mac and Fannie Mae

Shares in Europe and Asia have rallied after the US government said that it was taking over troubled mortgage giants Freddie Mac and Fannie Mae.
Investors hoped the largest bail-out in US history would prop up the country’s housing market and ultimately help to end the credit crunch, analysts said.
London, Paris, Frankfurt and Tokyo markets all rose by more than 3 per cent.
US president George Bush said the two mortgage lenders had posed “an unacceptable risk” to the economy.
Freddie Mac and Fannie Mae buy mortgages from approved lenders and then sell them on to investors – rather than lending directly to borrowers. They guarantee or own about half of the $12 trillion US mortgage market and are relied on by almost all US mortgage lenders. They have lost billions of dollars during the US housing crash.
Much of their bond debt was ultimately held by Asian banks, who had recently begun withdrawing their investment.
The most recent figures show that about 9 per cent of US mortgage holders were behind on their payments or faced repossession.
The rescue could cost the Federal government $200bn as it invests fresh capital into the stricken mortgage giants to keep them solvent.
But a collapse of the two lenders would have frozen US mortgage lending for years, and would likely have led to even steeper declines in house prices.
According to one widely-reported index, US house prices are falling at an annual rate of more than 15 per cent in major metropolitan areas, putting many people in negative equity.
The rescue plan reassured investors worldwide who feared that a collapse of the government-sponsored enterprises could have a ripple effect on financial markets, with further losses by major banks leading to yet further cutbacks in credit and lending.
In morning trading, London’s FTSE 100 index, was 3.8 per cent ahead before a technical glitch brought trading to a halt. It had lost 7 per cent last week – its worst showing in more than six years.
UK banking stocks were buoyed by the news from the US, some adding as much as 15 per cent. House builders also gained on hopes that the move could signal a turnaround in the sector.
Germany’s Dax-30 index was 3.4 per cent ahead and France’s Cac-40 added 4.8 per cent.
Meanwhile Japan’s Nikkei index closed up 3.4 per cent, while the Hang Seng index added 4 per cent.
And key indexes in Singapore, Australia and Taiwan were also higher.
On Wall Street, where the Dow Jones index shed 4 per cent across the previous five sessions, strong gains are also expected when trading begins.
“The markets are certainly going to rally today because investors are going to say ‘Maybe we can see light at the end of the tunnel in terms of the credit crunch’“, said Graham Neale of private stockbrokers Killik & Co.
The effective government takeover will lead to major changes in how the two mortgage giants are run.
As part of the changes, the management of the two companies will be replaced while the firms will be given access to extra funding to support their business going forward.
Paulson said the government was intervening in the wider interests of the financial system and of taxpayers since the financial position of the two firms was fast deteriorating.
The move is intended to keep the two companies afloat, amid fears that either could go bankrupt as borrowers default on their home loans.
But they have made a combined loss of about $14bn in the past year and officials were worried that they would no longer be able to continue functioning if such losses continued.
Banks around the world are highly exposed to the two companies and therefore, 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.
A rescue plan passed by Congress in July gave the US government the authority to offer unlimited liquidity to the two companies, and to buy their shares, in order to keep them afloat.