NEW YORK // While the debate over how to bolster two of America's largest home-loan buyers has suddenly dominated the economic agenda, international investors and the global economy have plenty to gain by keeping the two companies afloat, whatever the cost. Concerns about the health of the Federal National Mortgage Association, better known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac, plunged US financial markets into crisis last week. Stock markets and the dollar reeled on Friday, following a report that one of the White House's options was to take over one or both of the companies, along with their roughly US$5.3 trillion (Dh19.47 trillion) in combined obligations. White House officials struggled to reassure markets amid the biggest housing slump since the Great Depression. "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission," said Henry Paulson, the US treasury secretary. "We are maintaining a dialogue with regulators and with the companies."
But indications that the government was willing to consider stepping in and guaranteeing Fannie and Freddie's debt sparked a sharp rally in their bonds, about $140.1 billion of which are held by foreign governments, including those in the Gulf. Economists said that the global economy was exposed to more risk from letting the two companies falter than from having the government assume their debt, which would be very likely to push the beleaguered dollar lower.
"You should be more concerned about a weaker US economy than about the level of the debt per se," said Donald Hanna, the head of global emerging markets research at Citigroup. "For the rest of the world that's a much bigger deal than the structure of the obligations."
The latest concerns pushed US stocks down sharply last week, with key indexes dropping on Friday by more than one per cent and the Dow Jones Industrial Average finishing the week near its lowest point in almost two years. The US dollar also fell, dipping close to its all-time low against the euro. That helped send crude oil to a new record high. Currency traders are concerned that a bailout of Fannie and Freddie could saddle the US government with so much additional debt that it pushes the fiscal deficit higher and the dollar lower. "A perception that the US is no longer a safe haven for capital could produce tremendous strain on the dollar, as would fears of ballooning treasury commitments associated with a bailout," said James Hamilton, an economics professor at the University of California. But economists say this is a minor concern next to the risk that Fannie and Freddie might be rendered incapable of underwriting home mortgages, or worse, default on their debts. Any such scenario would probably accelerate the downturn in the housing sector by reducing liquidity in the secondary market for mortgages, reducing the ability of mortgage lenders to finance new purchases. With much of the American public's savings tied up in their home equity, the effect on consumer spending - and with it demand for manufactured imports and commodities, such as oil - could be dramatic, they say. Investors were therefore encouraged by statements by several key politicians, including Senator John McCain, the presidential candidate, in favour of government support for Fannie and Freddie. "They must not fail," said Mr McCain on Thursday, during a campaign stop in Michigan. Fannie Mae and Freddie Mac "are vital to Americans' ability to own their own homes", he added. Fannie Mae and Freddie Mac own or guarantee nearly half of all existing home loans in the US and are therefore considered essential to the smooth functioning of the home loan market. Fannie Mae was set up by the US government in 1938 to help Americans finance their homes, and privatised in 1968. To give it some competition, the US congress created Freddie Mac in 1970. Neither company lends money to homeowners directly. Instead, they buy mortgages from banks, packaging them into securities that are then sold for a fee to investors. By selling their loans for cash, banks reduce their exposure to any one homeowner and can so turn around and lend even more, thereby providing more money at lower interest rates to borrowers. Fannie and Freddie guarantee roughly $3.7 trillion in mortgages through their securities and have another roughly $1.6 trillion in debt outstanding. While these debts and guarantees are not backed explicitly by the US government, investors have long assumed that Washington would not let them default. This assumption about the safety of their bonds has allowed the two companies to borrow at rates only slightly higher than the US government. That has made them among a favoured class of investments for government-run funds from around the world seeking safe places to put foreign currency reserves and other export revenues. Gulf funds are estimated to hold roughly $25bn of Fannie and Freddie's debt, not counting any mortgage-backed securities they may also hold. But the subprime mortgage crisis has hit the two companies doubly hard. As defaults rise to their highest rate in 29 years, Fannie and Freddie are suffering growing losses meeting their guarantees. Fannie has already raised $6bn to offset write-offs against the declining value of its mortgage-backed assets. Freddie has raised $13.5bn since December. These losses, combined with the global credit crunch, are pushing up their own borrowing costs. Shares of Fannie Mae fell 22 per cent and Freddie Mac about three per cent, sending both shares to their lowest level in 17 years and leading a broader rout of financial stocks. The two companies' shares have fallen by about 80 per cent so far this year. This week's tumult was touched off by a backhanded buy recommendation issued on Monday by Lehman Brothers. In it, Lehman analysts argued that Fannie and Freddie would probably benefit from a proposed change in accounting rules that would require them to raise about $41bn in additional funds, more than they might be able to do in the current environment. The new rule stood to be so costly, the report reasoned, that the government was almost certain to exempt the two companies from it. Indeed, the administration of President George W Bush has reportedly been studying contingency plans for Fannie and Freddie for months, including a reported plan to take the companies over and place them in a conservatorship. Doing so would wipe out existing shareholders by diluting, or eliminating, their ownership. Christopher Dodd, the chairman of the Senate Banking Committee, said after meeting on Friday with Mr Paulson and the Federal Reserve chairman, Ben Bernanke, that various other options remained under consideration, including giving the companies emergency funding from the Fed. But the hope in Washington is that Fannie and Freddie can still raise whatever funds they might need from the markets.