If you live outside America you may be wondering who on earth are Fannie Mae and Freddie Mac. With names like that they could easily be some sort of Country and Western duo. And what about Indy Mac? He could be the little cousin who plays the banjo?
But no, these are but friendly and familiar names given to three components of the crippled US housing market.
Fannie Mae and Freddie Mac are by far the most powerful elements of that market as they own or guarantee some US$5.2 trillion of the US$12 trillion mortgages outstanding in America today.
The controversial intervention is already coming under criticism from those who do not believe it is the government’s job to bail out troubled companies.
The US government made the unprecedented move of offering both a lifeline should they need it in the future in an effort to restore calm to the markets and assure the world that neither company will be allowed to go bust.
As house prices have dropped in the US, Fannie and Freddie have experienced the ill effects of negative equity. The value of loans on their books is far above the value of the properties associated with them.
Shares in both companies have been falling since the housing bubble burst, but it was a speculative story in The New York Times that recently caused a wave of panic selling that led to this landmark government bailout.
Henry Paulson, the Treasury secretary, said he would seek approval from Congress to extend an increase in cheap credit to allow both companies to bolster their balance sheets.
He will also ask politicians to give him approval to buy shares in Fannie and Freddie if they need more cash.
The Fed, meanwhile, gave Fannie and Freddy access to the discount window it currently opens up to commercial banks in need of funds. Wall Street traders cheered the bailout package as shares in both companies rebounded strongly when New York markets opened on the morning after Paulson’s dramatic Sunday night speech on the steps of The Treasury.
Fannie Mae shares jumped 30% at the off while her sibling outfit Freddie Mac enjoyed a 20% surge. Prices soon settled down, however, but were still doing a lot better than they were the previous week.
The surging share prices were enough to prove that shareholders, at least, were satisfied that emergency measures unveiled by Paulson were enough to stave off financial disaster for the companies.
Bond traders were also more confident than before the surprise announcement as they signed up in droves for a US$3bn debt sale by Freddie Mac. But the controversial intervention is already coming under criticism from those who do not believe it is government’s job to bail out troubled companies. Indeed, look at Indy Mac’s predicament.
Indy Mac is just a bank from California, or at least it was until the Feds moved in and closed the place down, much to the chagrin of its thousands of customers.
Indy Mac specialised in so-called Alt-A mortgages, which are just a hair’s breadth away from the toxic subprime loans that caused the housing and credit market meltdown in the middle of last year.
The bank has since opened up again under the watchful eye of the Federal Reserve, which is now looking for a buyer to take it over for good.
Another 90 or so similar banks are on the sick list in America and could soon go belly up. Just like Fannie and Freddie they are public companies with shareholders who take risks – as companies are supposed to do in a free market.
If these companies take too many risks – such as putting all their eggs in the dodgy end of the mortgage basket – they will fail. And fail they should. So with his rescue package Paulson is telling us that Fannie and Freddie are too big and too powerful to fail.
The current credit crunch would be as nothing compared to the global financial carnage that would follow a collapse of either of them.
James Doran is a New York-based business columnist who has travelled the world for seven years as a foreign correspondent for The Times of London for whom he has also served as a bureau chief in Wall Street and Washington DC.
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