Another day, another stunning bail out.

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.


  1. Brian Tomkinson
    September 8, 2008

    Is it not the case that the difficulties at Freddie Mac and Fannie Mae are symptoms of the problem and not the cause? The cause was irresponsible lending to people who in many cases were known to be likely to default. This irresponsible behaviour no doubt enriched greatly those who perpetrated it and should be regarded as criminal. When you write, as you did recently, that falling house prices limit what people can borrow to sustain their lifestyle, you create the impression in my mind that you haven't learned the lesson of this crisis.

  2. Kit
    September 8, 2008

    Freddie Mac and Fannie Mae were already state agencies just with a private veneer. The only change is that this pretence has been removed by "nationalisation".
    If the US housing market does not turn round the US tax payer is looking at a $200billion bill – making the Northern Rock bill look like pocket change.

  3. Kevin Lohse
    September 8, 2008

    Another incisive and informative piece John. Thanks very much.

    It is worthy of note that the US move came in the middle of an exceptionally bitter and closely fought election campaign. At first sight, bearing in mind the way the Congressional system works, both sides will be able to claim credit for saving the "hard working bluecollar family" from disaster. The sting will be that as the Democrats have controlled Congress for the last 2 years, by claiming credit for this measure, the Republicans can campaign on getting the Democrats to acknowledge some responsibility for the deficit in the last 2 years.
    It is precisely because all these this bail-outs are political deals, like Northern Rock, rather than financial deals, I feel that the free world is going to suffer a longer period of Recession that would otherwise be necessary. I would suggest that what is happening is that the greatly inflated housing sector is being denied the necessary sharp correction. (I am a house owner) What is being touted as a bright way to manufacture a soft landing may well prove to be a small dyke which merely increases the effect of the tsunami of debt.

  4. APL
    September 8, 2008

    JR: "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."

    It is so simple Mr Redwood, politicians invaribly make matters worse. Let the market digest this move and then let us see what this does for the US$ and then US$ government bonds.

    JR: "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."

    A victim of the last manufactured Tory housing boom, I know what it is like to experience negitive equity.

    The problem is, all your (collective term ) fiddling with the financial levers will make no difference, the politicians manufactured the boom and now the people will suffer the bust. Again.

    While many MPs will be trying to decide which of their multitude of publically financed houses to sell or rent out, many ordinary people will find themselves evicted from their only house.

  5. Tony Makara
    September 8, 2008

    One has to wonder how much this decision was motivated by the desire to protect the Chinese and Japanese rather than the American homeowner? I suppose governments really ought to look at the wider picture, but I must say that these bail-outs do seem to be a quick-fix without much thought being given to the long term consequences.

    Perhaps we need to look at the culture of home ownership and ask whether it is simply beyond those on a modest income? We would all love to own a home, it is something fundamental to the human sense of security, but is it unrealistic to believe that everyone can be a homeowner? Especially the way the economy is structured with so many people in part-time low-paid work.

  6. Matthew
    September 8, 2008

    "In these cases there was no run on the institutions forcing the hand of the authorities. "

    But this is because the two institutions were already seen as having a government guarantee. When Northern Rock got its the run on the bank stopped almost immediately.

  7. Promise of Avalon
    September 8, 2008

    This all feels like someone or something is trying to make us all mad before our final destruction.

  8. adam
    September 8, 2008

    I really disgagree with your posts.

    What is wrong with the aspiration to own a home.
    In any case not everyone does, many people rent, especially migrants.

    Overreaction to events is a hallmark of the hysterical left, in my experience.

    1. Tony Makara
      September 8, 2008

      Adam, show me where I said its wrong to aspire to home ownership? I said perhaps it is beyond the financial means of some people. I feel a lot of people have taken on debt beyond what they can control, their intentions were good but not based on a rational assessment of their finances. There certainly is now a media culture that promotes home ownership, but with a view to buying, renovating and selling on properties at inflated prices, the culture is no longer about simply owning a home to live in. Many people have been seduced by this culture.

      1. adam
        September 9, 2008

        Your implication is we need some state regulation of who can own a house. Thats how im reading it.

        "When you say we need to look at the culture of home ownership," what are you implying?

        1. Tony Makara
          September 9, 2008

          Adam, sorry I missed your reply. What I mean is that 'we' that is all of us, need to ask lenders to show a bit more decorum when deciding whether to grant credit to specific individuals, we also need to do more to educate people against borrowing on the value of their home. I should like to see a form of personal finance taught in our schools as part of the curriculum, so that young people leave school with a grounding in how finance works. As David Cameron was pointing out earlier in the year, credit/debt isn't a bad thing as such, it can be a great help to people, the problems occur when a person is unable to manage debt, this is where we much change the culture, so that people understand how money can work for them rather than against them.

  9. adam
    September 8, 2008

    That was a reply to Tony Makara

  10. Blank Xavier
    September 9, 2008

    > In these cases there was no run on the institutions forcing the
    > hand of the authorities."

    I may be wrong, but I suspect this is not true.

    Fannie earns about 10 billion a year – at 30bps spread. At 130bps that 10 billion drops to about zero. Expected losses over trend on their book – well, that's the big unknown. Something approaching 100 billion maybe. Fannie needs all of it's earnings for the next couple of years to manage its losses. If spreads remain at 130, they have *no earning power* which leads them to be profoundly insolvent.

    The longer Fannie has to issue debt at 130bps, the more the Fed will have to pay off in debt repayment. So the Treasury has a choice; wait with fingers crossed and hope spreads drop back to 30bps (which hadn't happened and wasn't going to happen) or get in there ASAP to minimize losses. Debt is issued at a high rate – a couple of billion dollars a quarter – so this is a lot of money.

    As it is, spreads have only tightened to about 90bps. The Treasury may be going to lose a *lot* more money than it bargained for – presumably is they were assuming spreads would drop back to 30bps or so and mean they could use earning power to neutralise losses.

    The problem may be that it's all very well providing a bailout, but people *still do not know the scale of losses to be expected at Frannie*. The quality of the loan book is still unquantifiable. So having a bailout – you still don't know where you stand if you buy their debt – you still *don't know* how much risk you're taking – and how can you assume the Treasury will really back up their full bailout when you know *they* don't know how much it's going to cost.

  11. Kevin Lohse
    September 9, 2008

    Blank Xavier on 09 Sep 2008 at 7:33 am
    Thanks. I was very vague about the workings of FM&FM. Anyone out there who can cast further light?

  12. figurewizard
    September 9, 2008

    The rescue of Freddie Mac and Fannie Mae was inevitable as their collapse would have precipitated a global financial disaster. However the problem we are all now faced with is how we stop this from ever happening again. Like our own little local difficulty with Northern Rock, it appears that it was not the lack of regulations that was the problem it was that the regulators utterly failed to take action in good time. Whether or not those responsible in the US are taken to task remains to be seen but the fact is that none of the guilty parties here in the UK have been made to answer for their own failures.

  13. Blank Xavier
    September 9, 2008

    Spreads are now at 68.8bps – they went up 5 points yesterday.

    This may then be the rough settled value – in which case the Treasury is looking at (wild guess time) about 32 billion USD total cost for Fannie Mae. Maybe another 15 or so for Freddie Mac, call it 50 billion in total.

  14. sandrar
    September 10, 2009

    Hi! I was surfing and found your blog post… nice! I love your blog. 🙂 Cheers! Sandra. R.

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