Freddie and Fannie: an American racket

America's credit crisis has already had as many false endings as your average slasher film. And now, just as you thought we were out of the woods, along come Fannie Mae and Freddie Mac, which may sound like an old Vaudeville act but in fact are the two biggest players in America's mortgage business.

Last week, their share prices fell sharply on reports they were now in deep trouble. If they were to collapse, it would make the Bear Stearns fiasco look about as significant as a bounced cheque. Hence President Bush's intervention today, offering taxpayer help to prop them up.

Fannie Mae - officially the Federal National Mortgage Association - was created in 1938 by President Roosevelt to encourage banks to issue mortgages during the Depression. It was privatised in 1968. Freddie Mac - the Federal Home Loan Mortgage Corporation - was created in 1970 to support home ownership and the building of rental housing for people with lower incomes, and is also a private company.

Both Fannie and Freddie are subject to federal oversight and are traded on the New York Stock Exchange.

What both firms do, essentially, is buy the mortgages issued to home-buyers by banks. This enables the banks to cash in the loans they have issued immediately, without having to wait for all those payments to come in, and issue more loans. Freddie and Fannie then package their loans into bonds and sell them as supposedly conservative investments back to investors.

The problem now is that no investors are buying Freddie's and Fannie's loans, so Freddie and Fannie cannot buy loans from the banks. The drying up of their spigot has gummed up the entire mortgage system.

Compounding this is the fact that over the past two decades or so, Freddie and Fannie have behaved less like quasi-governmental outfits, goosing the housing market as and when necessary, and more like the worst run American corporations, gorging on debt and lavishing their senior executives with pay and perks. They were given the advantages of a government-backed entity - such as lower borrowing rates and generous tax exemptions - and yet behaved like the most piratical free-marketeers.

Their palatial headquarters in Washington DC became the hub for the entire housing and mortgage industry's successful efforts to limit regulation and provide tax breaks for home-owners.

Instead of helping poorer families onto the first rung of the property ladder, as they were originally intended to do, they have acted like steroids on the property market, insuring billions of dollars in mortgages which in any rational market would never have been written, and driving up property prices beyond their natural level.

Between them they have annual revenues of more than $80bn and own or guarantee nearly half of America's $12 trillion mortgage market. And thanks to some insane financial management in recent years, the two companies are little more than giant piles of debt, teetering on mere slivers of capital.

Even a slight rise in late payments, defaults and foreclosures by mortgage holders would have threatened them. Instead, they have been hit by the worst housing market fall since the 1930s.

Rather than helping homeowners through the crisis, they now have to be bailed out by the taxpayer. Shares in the two companies have fallen 90 per cent in less than a year and anyone trying to get a mortgage these days is finding it fiendishly hard. Their woes have negated the effect of the Federal Reserve's series of rate cuts earlier this year, which were intended to stimulate the market.

In 2004, the former Fed Chairman, Alan Greenspan, warned that Freddie and Fannie's expansion was threatening the financial markets. Neither Congress nor the federal government's housing overseers did anything to stop them. Instead, the taxpayer is yet again there with the bucket, bailing out another private sector implosion. How many more there will be, no one knows. ·