Scandal of the Freddie and Fannie bail-out

The nationalisation of America's mortgage industry - or to use the US Treasury's coy term, its placing under "conservatorship" - will surely go down as one of the great scandals in financial history: £110bn of taxpayers' money to shore up £3 trillion of American home loans issued in the housing market frenzy of the past few years.

For a brief moment, however, stock markets from Tokyo to London rallied as once again the prospect of a far deeper financial crisis was averted.

British banks were reported to be relieved because they have invested billions in bonds insured by Freddie Mac and Fannie Mae, the two US firms who underwrite around half of America's mortgage market and have had to be bailed out. Fewer losses for British banks means more money to lend to hard-pressed British consumers. Or so they say.

Asian central banks were also breathing easier. They have been buying hundreds of millions of Freddie and Fannie bonds in recent years as they viewed them as a low-risk dollar-denominated investment.

Shareholders in the two firms, however, stand to lose everything. For years, Fannie and Freddie have been two of the most popular stocks in ordinary Americans' portfolios. They were steady performers and seen to be less risky than other firms because of the implicit guarantee that they were backed by the government.

The conservatorship plan, however, erases most of the equity value in the firms, which will cause pain to millions of retirement saving accounts.

Henry Paulson (left), the US Treasury secretary, argued that the bail-out would return America's economy to health by enabling consumers to get home loans, car loans and other forms of credit. "Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," he said.

In the short-term, the plan should restore some faith in America's battered housing markets. House prices have already fallen 18 per cent from their peak in the summer of 2006, with little sign of slowing. Many experts believe that solving the housing problem is the key to solving America's broader economic problems. If only consumers could once again depend on the value of their homes, and borrow against them, all would be well again.

And yet, if anything, the bail-out shows how dependent the global economy has become on the borrowing habits of American consumers.

The US Treasury is standing with its bucket in the sodden basement of the American economy, declaring temporary victories after each flood, too exhausted to patch up the gaping holes in the roof: excessive borrowing, weak manufacturing, dismal government finances.

One of the more admirable aspects of the Paulson bail-out is the elimination of lobbying by Freddie and Fannie. Over the past decade, the two firms spent over £100m paying Washington lobbyists to stave off closer government scrutiny of their activities. The politicians who succumbed to this lobbying, Democrats and Republicans alike, escape scot-free.

It is a shame the government does not go further and actively seek to recoup that money on behalf of the taxpayers now footing the bill for the firms' excesses.

Former senior executives at the two companies may also be feeling uneasy today. Franklin Raines (left), the CEO of Fannie Mae between 1999 and 2004, was paid over £20m in that time and walked away with more than £10m in pension benefits.

The same executives who claimed the market set their compensation turned out to be helpless when the market turned on their business, jeopardising the livelihoods of millions of Americans.

Paulson probably had no choice in the end. He could have let the markets sort this out, but it might have taken years and inflicted all kinds of economic pain. The investor Warren Buffett said: "Secretary Paulson has made exactly the right decision for the country. He is minimising the problem of moral hazard and maximising the benefits for the housing market and for the smooth functioning of financial markets."

But it is a disgrace that both the public and private sectors let it come to this. ·