The importance of Freddie Mac and Fannie Mae

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By Simon Atkinson Business reporter, BBC News

Fannie Mae and Freddie Mac are central to the US housing market

When UK lender Northern Rock hit difficulties last year, the queues forming outside its branches across the UK provided a very visual image of the problems that it faced.

A few months later the beleaguered bank was taken into government hands after it was nationalised, with loans worth £100bn on its balance sheet.

It was doubtless a disaster for shareholders, the Rock and the government - but is perhaps put into perspective by the troubles faced by Freddie Mac and Fannie Mae.

Together, the two firms own or guarantee about $5.3 trillion (£2.7 trillion) worth of home loans - about half the outstanding mortgages in the US.

That is about 25 times as big as the Rock's obligations, and twice the size of the UK economy.

If they were unable to lend, the US housing market would probably implode - with dire consequences for the financial system and the entire global economy Robert PestonBBC Business Editor

Now the worries about their financial health have intensified so much that the US government has been forced to come up with a promise that taxpayers will prop them up to prevent their problems becoming a crisis.

'Implode' risk

There will be no queues outside branches of Freddie Mac or Fannie Mae - quite simply because there are not any.

In fact, despite them guaranteeing or owning just under half of the entire US mortgage market, you cannot actually get a home loan from either firm.

But while they are invisible to the average borrower, the two firms are highly influential institutions and are key to the US housing market.

BAIL-OUT DETAILS The US Treasury is proposing: Increasing the amount of credit Freddie Mac and Fannie Mae can accessAllowing the Treasury to inject money into the company in return for shares

"If they were unable to lend," says BBC business editor Robert Peston, "well, the US housing market would probably implode - with dire consequences for the financial system and the entire global economy."

As one US Treasury official puts it, the two firms are "way too intertwined with everyone in the world" to fail.

Because the firms' debt is held by both central banks and small banks, there was a worry that "all hell would break loose" if their shares plunged again when the markets reopened, they added.

Affordability argument

As the value of US homes soared, the importance of these two institutions grew in allowing people to purchase property.

It has been drawn to the Americans' attention in the past by regulators and financiers internationally that this is an unstable situation Howard DaviesFSA founding chairman Fannie Mae and Freddie Mac are both shareholder-owned companies mandated by the US Congress to provide funding to the housing market - ensuring steady flow of mortgages.

The two firms do not lend directly to homebuyers, instead buying mortgage debt from approved lenders such as banks, and then selling it on to investors.

Almost all US mortgage lenders, from huge financial institutions such as Citigroup to small, local banks, rely on Fannie Mae and Freddie Mac, looking to them for the funds they need to meet consumer demand for mortgages.

The two firms argue that they make home ownership more affordable, lowering the interest rates on the 30-year mortgages that they guarantee.

But their peculiar status has left them in a grey area between being government owned and private sector, with potential risks to the taxpayer should they need bailing out.

'Time bomb'

"For decades the US government and international investors have conspired in a convenient fiction, that Fannie Mae and Freddie Mac are supported by the state and yet are not formally on the public sector balance sheet," the BBC's business editor says.

"That's allowed them to raise money for lending to US homeowners at much lower rates than would have been possible had they been normal commercial banks."

FREDDIE MAC & FANNIE MAE The two firms: Buy mortgages from approved lenders and then sell them on to investors - rather than lending directly to borrowersGuarantee or own about half of the $12 trillion US mortgage marketAre relied on by almost all US mortgage lendersAre looked to for funds to meet consumer demand for mortgagesLink mortgage lenders with investors - keeping the supply of money widely available and at a lower costHave no direct UK equivalent <a class="" href="/1/hi/business/7502310.stm">Q&A: Freddie Mac/Fannie Mae </a>

Meanwhile, Howard Davies, the founding chairman of the Financial Services Authority, describes them as "peculiar institutions".

The firms were "a time bomb that has been ticking" since they were sold off in the 1970s, he added.

"It has been drawn to the Americans' attention in the past by regulators and financiers internationally that this is an unstable situation but so far they have been unprepared to anything about it.

"It's about time they did."

Close links

The problems at Freddie Mac and Fannie Mae have overshadowed the collapse of California-based IndyMac Bank - the second-largest financial institution to fail in US history, regulators say.

IndyMac had been struggling to raise funds and stay in business in one of the states worst hit by the US housing market slump.

Without similar close links to government it could not weather the storm.

But it seems that Washington wants to keep Freddie Mac and Fannie Mae alive and kicking, not least so that they can play a key role in reinvigorating the housing market.

The cost to taxpayers will be large, observers predict, but they argue that the price of not intervening would be far worse.