The US Treasury has moved to support Freddie Mac and Fannie Mae, the two large mortgage companies that dominate the US housing market. In what amounts to nationalisation, the Treasury has pumped in new equity capital and offered guarantees.
Fortunately this action does not come straight out of the Northern Rock book of mismanagement. In these cases there was no run on the institutions forcing the hand of the authorities. They were thinking ahead. Nor will nationalisation mean halving the mortgages offered and financed by the companies, as it does at Northern! The aim is not to sack staff and reduce the number of mortgages, as in the UK, but to make cash available and to try to stabilise a tumbling mortgage and property market. To this extent it is good news, and accounts for the immediately favourable response of the markets.
I am glad I am not an American taxpayer. This is a huge budget commitment. The Treasury says that with careful management the taxpayer will have to put up very little. Let’s hope they are right. The fact remains that this is the biggest ever rescue, and the US taxpayer now effectively stands behind half of all American mortgages, offering to pay losses on them if customers default. That’s good news for all the other banks in the system but bad news for taxpayers.
It shows how serious the present crisis is that the US authorities think they need to take such drastic action. Who would have thought a Republican President would end up nationalising the world’s two largest mortgage lenders? I do not recall that in the manifestoes four years ago. What kind of message does that send out to bankers and mortgage companies about how they should behave?
It is true that existing shareholders in the two FMs may lose, but everyone else implicated in making too many bad loans will have the protecting arm of the Treasury around them. Is it perhaps time for Mr Darling to make another one of his speeches about moral hazard? Will be hearing anything on this subject from the Governor of the Bank of England, who used to be strongly against such an approach?
To all my readers who think I have been too ready to seek action from the authorities on both sides of the Atlantic that can help stabilise house prices, I plead guilty. Collapsing house prices brings down much else with the fall. Many families pay the price with lost jobs, shattered dreams, repossessed properties. No sensible person wants that. I also think there has to be some balance in action taken, to avoid a worse problem in managing public debt and the government deficit. The art of getting through a crisis like this is to say and do just enough to allow private sector solutions to emerge. Shunting all or most of the problem onto government balance sheets does not solve it. It just moves the problem on, to emerge in a different form on a different day.
If these institutions have lost a lot more than is so far reflected in their write offs, then the taxpayer now will have to pay for the losses. If these institutions were just suffering from too little overall liquidity in markets so that investors were being unduly pessimistic, there were cheaper and easier ways for the authorities to sort that out.
One way or another the governments are taking over the bad loans and the portfolios of debt where confidence has been damaged. The European Central Bank has been busily taking in such paper to keep its banking system liquid. The Bank of England has done more of the same. The UK taxpayer has taken on responsibility for all the Northern Rock book, and now the US taxpayer is the reluctant owner of a couple of huge mortgage houses. The taxpayer interest has not been as well looked after as it should be. Of course Central Banks should take in poorer paper and make money available when it is needed, but they should do so with large enough discounts and requirements for write offs that fully protect the taxpayers who pay their wages.