US treasury bails out mortgage firms

An emergency plan by the United States government to stabilise the nation’s two biggest mortgage finance corporations won cross-party support last week and proved sufficient to calm fears of imminent collapse.

After a weekend of frenetic activity the US treasury announced it would seek approval from Congress to lend billions of dollars of extra funds to Fannie Mae and Freddie Mac and, if necessary, to use taxpayers’ money to buy shares in the embattled companies.

The intervention bolstered enough confidence for Freddie Mac to complete a scheduled $3-billion auction of debt. Executives at Fannie and Freddie insisted it was “business as usual”.

The Dow Jones Industrial Average rose more than 100 points before rumours of problems at a major Ohio-based retail bank swept away the gains before lunch.

Democrats said they would support the government’s support package, which is likely to be tacked on to a housing bill and rushed through Congress this week.

Christopher Dodd, chairman of the Senate banking committee, said he believed Fannie and Freddie were “very solid” institutions. “The fear that has been generated over the past number of days is not helping matters and I hope the actions taken by the treasury and the Federal Reserve [Bank] are going to calm those concerns.”

The Republican presidential candidate, John McCain, said the actions were “correct” and would “preserve the ability of Americans to obtain loans in order to buy a home and be able to afford mortgage payments they’re having to make”.

In effect a federal guarantee, the package is a reversal of years of insistence by the US treasury that Fannie and Freddie were private enterprises that stood or fell on their own. Abby Joseph Cohen, a senior US investment strategist at Goldman Sachs, said: “To calm the markets at this point was their number-one goal and, at least thus far, it appears they’ve been successful.”

But fear quickly resurfaced as shares in National City Corporation dived by 28%, forcing it to issue a statement denying that it was suffering a run on deposits.

The Cleveland-based bank, which had $97-billion of deposits in the first quarter, said it had a $12-billion cushion of short-term liquidity and was seeing “no unusual depositor or creditor activity”. The plunge came as investors queued to withdraw money at branches of IndyMac Bancorp, a California bank seized by regulators on Friday.

As the authorities are obliged to intervene in failing institutions increasingly frequently, there are calls for a broader rethink of the regulations surrounding the risks taken by banks.

Lawrence White, an economics professor at New York University’s Stern business school, said the Federal Reserve’s decision to open its lending “discount window” to institutions begged fundamental questions. “We as a polity need to figure out, especially for investment banks, what kind of prudential regulation is going to go along with this lending regime.”

Created to broaden affordable access to housing, Fannie and Freddie back some $5,3-trillion of mortgage debt, accounting for half of the US’s home loans. In a research note Barclays Capital said they were “so intertwined in the fabric of global capital markets that a failure would cause not just a US recession but a global depression”.

Rajiv Setia, a Barclays credit analyst, said Freddie could make provisions over the next two to three years for losses of $30 to $35-billion and Fannie could write off $40 to $45-billion. But he said the mere promise of treasury backing could be enough to keep them afloat without any actual government money: “The crisis has been averted but in the longer term I think the business model will have to change.”

Reports suggested that some in the White House had contemplated a more drastic path of installing board members hand-picked by the president, although this was rejected.

Citigroup advised its clients to buy shares of Fannie and Freddie on the grounds that the crisis has been one of confidence rather than of financial fundamentals. “We expect calmer heads to prevail in Washington and on Wall Street,” said its analyst Bradley Ball. —

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