Weekly international investment round up to 12th September 2008

The US Government takes over Freddie and Fannie

Is the credit crunch over?

AT one fell swoop the American government threw a security blanket over the US loan market last week and in turn became their nation’s most important mortgage lender.
Whilst too early to state if 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 but then fell back when troubled US bank Lehman Brothers announced huge losses.
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 remained a government agency until 1968. Freddie Mac which is short for ‘Federal Home Loan Mortgage Corporation’w 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 pounds on its balance sheets. Freddie and Fannie jointly guarantee around $5.3 trillion dollars 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.
Instead, the two firms 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 dollars 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 taxpayers’ money fully backing these institutions old debt can be protected whilst new debt will be taken up by reassured investors and thus the wheels of the capitalist system can be re-oiled!
Significantly, historians and economists may look back upon this intervention as a real wshifting point in America’s free-market model.