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In early September, the Federal Housing Finance Agency (FHFA) leapt to the aid of the two stricken mortgage guarantors, Freddie Mac and Fannie Mae, invoking a procedure known as 'conservatorship'. Under the system, the two companies will effectively be nationalized and run by the FHFA until such time as the market recovers. The two firms guarantee around 50% of all existing mortgages in the US and have suffered greatly from the ongoing liquidity crisis. Indeed, the government bailout was a formality since the strategic importance of the two mortgage guarantors in the US economy rendered them too big to be allowed to fail.
Freddie Mac and Fannie Mae purchase mortgages on the secondary market before packaging them up as mortgage-backed securities (or bonds), which have been purchased by financial institutions around the world. This includes the UK, where the Bank of England permitted their use while it was attempting to shore up its domestic financial markets. The move by the US authorities will ensure that UK pension funds will not lose out as they have invested fairly heavily in the bonds, which will now be covered by the government. The main losers in the fallout from this move will be investors in shares in the two companies, as they will receive little to no return. This is likely to result in the closure of many small banks within the US.
In the UK, the knock-on effect on the stock market has been positive, with banks such as HBOS making large gains. However, these gains are relatively small in comparison with the magnitude of the slump in banking share prices witnessed since the beginning of the credit crunch in August 2007.
The likely outcome for the UK housing market is less clear cut. However, for UK banks holding large amounts of mortgage-backed securities on their balance sheets, it should prevent them from having to make further write-downs. Furthermore, the injection of confidence in the value of mortgage-backed securities might allow banks to regain the trust of their peers and free up more funds for inter-bank lending. This would drive up the availability of funds in the mortgage market, allowing the housing market to recover. However, this recovery will not happen overnight, so it seems that the UK housing market is not out of the woods just yet.
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