Mark Lamb | Wednesday, 10 September 2008

The beginning of the end

Weekly international investment round up to 9 September 2008

At one fell swoop the American government has thrown a security blanket over the US loan market and in turn became the nation’s most important mortgage lender.
Whilst too early to state that their action of taking over the two companies which account for approximately half of all America’s outstanding mortgage debt is going to end the world wide credit crunch, this event is being seen as a real turning point and could at least signal the beginning of its end.
Following the news stock markets surged worldwide on Monday in the hope that the bail-out of Fannie Mae and Freddie Mac would help forge an economic recovery and stop the worst US housing slump since the Great Depression.
Fannie Mae, short for ‘Federal National Mortgage Association’ was founded in the 1930s at a time when there was limited funds available for families to buy their own homes and was a government agency until 1968. Freddie Mac which is short for ‘Federal Home Loan Mortgage Corporation’ was created in 1970 to provide competition to Fannie Mae.
I am sure we can all remember the recent Northern Rock fiasco which eventually led to the UK government nationalising the bank, at the time Northern Rock had loans worth £100 billion on its balance sheets. Freddie and Fannie jointly guarantee around $5.3 trillion worth of loans which is almost 30 times the size of Northern Rock’s. However, this time there have been no worried customers queuing around the block as neither Freddie or Fannie have branches and no borrower directly holds their home loans with them.
The two firms instead buy mortgages from approved lenders and then re-package and sell this debt on to investors thus keeping the credit cycle rotating. This system has led them to being so closely intertwined with domestic and international financial institutions that their collapse would spell utter economic chaos.
The problems began when ordinary American homeowners could not pay back their home loans which left Freddie and Fannie accountable. They lost more than $3 billion alone between April and June this year, resulting in a sharp fall in their share values and a lack of trust and investment in their repackaged products.
It would appear that the Federal Government acted now for two reasons.
First, accounting flaws which overstated the firms’ capital resources and financial stability have been found and reported upon by the New York Times and secondly, as a reaction to the considerable pressure brought on by commercial entities in both China and Japan which are Freddie and Fannie’s two largest overseas investors. Really, the US Government had no choice but to intervene.
Clearly, it is now hoped that with the US Government and tax payers’ money fully backing and safe-guarding these institutions old debt can be protected while new debt will be taken up by reassured investors and thus the wheels of the capitalist system can be re-oiled!
Significantly, following this intervention historians and economists may look back upon this time as a real shifting point in America’s free-market model.

Mark Lamb is Director of FPC Investment Consultants who are Independent Financial Advisers and regulated by the MFSA to provide investment services under the investment services act 1994. For further details please contact Mark Lamb, by email on [email protected] by phone on 21318008 or through FPC’s website www.fpcmalta.com
This article does not intend to give investment advice and its contents should not be construed as such. Information in this article has been obtained from various public sources and is given by way of information only. Readers are always encouraged to seek independent financial advice before making any investment decision