US mortgage giants, Fannie Mae and Freddie Mac are to be supported by the US Government to stop their possible collapse or a loss of confidence in them badly damaging the US housing sector,economy and financial system. In a dramatic statement at around 8 am this morning, Sydney time, US Treasury Secretary , Hank Paulson indicated he would seek blanket authority from the US Congress to aid the two struggling mortgage giants. The move came only hours before Freddie Mac had been due to sell $US3 billion worth of short-term debt, a move that would have seen if the market had wanted to support them.  It is now clear there was every opportunity that the issue would have failed, thereby questioning the credit worthiness of the USA itself because debt from the two mortgage groups is regarded as being tantamount to US sovereign debt. Paulson will ask the US Congress for a “temporary” increase of the companies’ lines of credit with the Treasury from the current $US2.25 billion each, and the right to buy equity “if needed.”  The plan, if it is given congressional approval, would give Paulson power to buy an unspecified amount of stock in Fannie Mae and Freddie Mac. A third element of the proposal would give the Federal Reserve a “consultative role” overseeing the companies’ capital requirements.  The Fed also announced it will let the companies borrow directly from the Fed at the same discount rate as commercial banks. The rescue and support package is similar to the way the Fed, Treasury and others bailed out Bear Stearns in March and stablised financial markets. US media reports had said over the weekend that the US Treasury would issue a statement of support for both groups this morning, before trading in Tokyo opens. There were reports in two News Corp papers on either side of the Atlantic of a possible support action from the US Government. The London Times reported that a $US15 billion injection of capital from the US Government was being considered among a list of possible options, while the Wall Street Journal reported on the weekend that a government support package could be announced Sunday night or early Monday in time to support the bond issue by Freddie Mac. The Journal reported that the US Government wanted to make sure the money helped the mortgage markets and not shareholders in both quasi-US groups.  The debt of the two mortgage giants is considered to be on the same ranking as the US Government debt in the minds of the market. So any problems with it could hurt the overall US debt markets. A move to buy the debt to be sold later tonight, by the Treasury or by the Fed, could send a support signal, like they did with the Bear Stearns rescue in March. That was started on a Thursday night and finished the following Sunday evening while 60 Minutes was airing in the US on CBS, but before the Tokyo stock market started trading Monday morning (Australia didn’t matter). Certainly Russia, which holds $US100 billion of US Government agency debts in its official reserves (including Freddie Mac and Fannie Mae) considers the agency debt as on a par with the debt of the US Government, according to a statement from the Russian Finance Ministry Friday and reported on Reuters. Other countries (China?) would have big holdings as well and they would not expecting a sharp rise in losses on that debt to the point where it raised questions about its backing. The Freddie Mac and Fannie Mae problems raise enormous questions about the credit worthiness of the US and there’s a geo-political side to the whole situation. The US can’t contemplate letting the two companies go broke: it would be tantamount to the US defaulting. Nor can the Bush Government or any government takeover over both mortgage groups: the $US5 trillion in dent would double the US national debt (but probably legitimise a grey area) and hurt the value of the dollar and trigger an enormous bout of financial instability.

Even though a takeover would see trillions in assets added to the US Government’s books, the markets would ignore that. It could see the US Government become the biggest loser from the subprime mess and credit crunch.

That they have gone half the way indicates how worried the uS is about the stability of the system, with Freddie and Fannie the focal points.

The fears about Freddie Mac and Fannie Mae is that they do not have enough capital to handle any sizeable loss in coming months or years from falling US house prices. Some commentators argue that if their mortgages were marked down to fair value (like many banks have to do), then they might not be solvent. 

Both groups said Friday they had enough capital but there were reports that Goldman Sachs was looking to raise money for one of the duo’s capital base and not new debt.

If the latest help proposals from the US Congress for struggling US homeowners facing foreclosure are to work then Fannie Mae and Freddie Mac will have to have robust capital bases because they will be required to play a major part in supporting the tottering US mortgage market.

US regulators (and the two firms themselves) say the duo have enough capital

“They are adequately capitalized, holding capital well in excess of” the requirements, the Office of Federal Housing Enterprise Oversight, said in a statement quoted on Bloomberg.” They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets.”

According to broking estimates, also quoted on Bloomberg, Fannie Mae and Freddie Mac would have to post pre-tax losses and write-downs of about $US77 billion before the US would be compelled to start a rescue. The companies have already raised $US20 billion to cover losses from the highest delinquency rates on housing in 30 years.

According to the two companies they lower interest rates on the 30-year fixed rate mortgages they guarantee, reducing the costs of home ownership for many Americans.

They buy mortgages from lenders and repackage them as securities for investors: this is securitization and it’s on the nose everywhere because of the credit crunch.

But in the US these companies are much more deeply involved in the housing finance sector because of their longevity and quasi-US Government status. They have a long history of securitising mortgages, even though bad times in the past. The home loan securitisation markets in countries like Australia and the UK are much younger and have less resilience. 

That’s why they have been shutdown by the credit crunch and the collapse or departure from the sector of leading players.

Fannie Mae and Freddie Mac provide lenders more funds to make further loans. Their automated underwriting systems have standardized mortgage lending and evened out regional US credit differences. They have become essential to the recycling of funds into US housing.

That’s why they have been caught by the credit crunch and subprime morass. Even though they are chartered by the US Congress, that didn’t prevent them from making many of the same mistakes that privately- owned funders did.

On top of that the two groups’ holdings of existing mortgages and securities are so large that they have continued to be battered by the 14-15% drop in US home prices in the past year.

That US Government charter, but private ownership, has placed them in a grey area of being neither wholly Government-owned, or wholly private: their shares trade on the New York Stock Exchange. That’s why they are called “Quasi-Government Sponsored Enterprises”

Their charters entitle them to $US2.5 billion lines of credit to the Treasury that each firm could draw on in an emergency, helping to add to the impression of government approval and support.

The US Government could very easily give them access to that line of credit, or merely increase it to show support.

This assumption by financial markets that the government would bail them out in a crisis means Fannie Mae and Freddie Mac can borrow more cheaply than purely private financial institutions.

At the same time, the companies are limited from lending directly to home buyers or from pursuing any other business line than mortgage finance. There are also upper limits to the size of mortgages they can buy.

Fannie Mae was originally called the Federal National Mortgage Association and was created in 1938 as part of a campaign to expand the US secondary mortgage market and boost homeownership as the country emerged from the Depression. The US Congress launched Freddie Mac, originally the Federal Home Loan Mortgage Corp, in 1970 to further expand home loan finance.