What are Fannie Mae and Freddie Mac?They are publicly traded companies based in the US that were created by the federal government in 1933 and 1968 respectively to provide liquidity to the mortgage market and bolster homeownership.
Their size has ballooned to the point where they now own or guarantee almost half of the $12,000 billion US mortgage market. As the housing crisis has deepened and lenders have pulled back, Fannie Mae and Freddie Mac have accounted for an even greater 70 per cent chunk of new mortgages.
Why are they experiencing such turmoil?Fannie Mae and Freddie Mac make their money by charging a fee to guarantee mortgages that they purchase and repackage as mortgage-backed securities. As home prices have fallen and foreclosures have risen across the country, they have incurred huge losses, which they have tried to tackle by raising capital.
What would happen if Fannie Mae and Freddie Mac went bust?If the two companies collapsed, the consequences could be disastrous for the global financial system. The US mortgage market would be likely to grind to a halt, prolonging the housing crisis and probably delaying any chances of an economic recovery. Even worse, investors around the world are holders of Fannie Mae and Freddie Mac debt, which has been considered one of the safest securities available. A sharp sell-off of these instruments would further deepen the global credit crisis.
Isn't the government supposed to stand behind Fannie Mae and Freddie Mac?The US government has never explicitly said it would guarantee the two companies' obligations. However, because of their importance to the financial system, many investors have assumed they are "too big to fail". That confidence is being put to the test, although the debate is less about whether the US will step in to rescue Fannie Mae and Freddie Mac and more about how.
What options are open to policymakers such as Hank Paulson, Treasury secretary, and Ben Bernanke, Fed chairman?The most dramatic would be for the government to invoke "conservatorship" powers, in effect taking over Fannie Mae and Freddie Mac by wiping out common shareholders but protecting debt-holders and allowing the companies to keep providing liquidity to the US mortgage markets. However, other intermediate steps could also be taken, including lowering the capital requirements of the two companies, which would delay any technical insolvency, or allowing them to access emergency lending facilities such as the Fed's discount window.
On Friday, Mr Paulson sought to dismiss any talk of nationalising them by saying the Treasury was working to support the two companies in their "current form" - owned by public shareholders.
Nevertheless, talks about their future continued over the weekend. - ( Financial Times service)
