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News Analysis: Will U.S. takeover of mortgage giants work?
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18:29, September 08, 2008

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The U.S. government announced Sunday a historical plan to take over the countries' two mortgage giants Fannie Mae and Freddie Mac.

This is the third time and also the biggest step this year that the U.S. authorities have made a big policy announcement in efforts to recover the country's mortgage market and the economy as a whole.

Under the plan, Fannie, formed after the Great Depression and spun off in 1968, and Freddie, created in 1970, will be placed into a government-run conservatorship.

Though not all of the plan details have been revealed, it is expected that tens of billions of dollars from taxpayers will be poured to buy the two companies' securities.

It appears that investors who own the companies' common stock will be virtually wiped out. Preferred shareholders, who have priority over other shareholders, may also end up with little. Holders of debt, including many foreign central banks, are expected to receive government backing.


The two companies' performance is crucial to the U.S. mortgages sector as they own or guarantee almost half of the country's total12 trillion U.S. dollars in outstanding home mortgage debt.

Their combined losses of nearly 14 billion dollars in the last 12 months have aroused concerns over their sustainability in the business.

As Treasury Secretary Henry Paulson put it in an announcement, they "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."

"Our economy and our markets will not recover until the bulk of this housing correction is behind us," he said.

He hoped that the latest move on providing fresh capital to the two firms will eventually lead to lower mortgage rates, stimulate home buying demand and stabilize house prices that have plummeted.

"The clarity and certainty it will provide to the status of the two institutions should have a stabilizing effect on the markets, banking system and the mortgage industry," Federal Insurance Deposit Corp. Chairman Sheila C. Bair said in a statement.


Overall, the government's announcement has been hailed by the Wall Street as a positive measure.

For those financial giants around the world such as Citigroup,Merrill Lynch and UBS that have huge investment in U.S. mortgage market, the move should be interpreted as good news.

As a result of the government's intervention, the cost of borrowing for Fannie Mae and Freddie Mac should decline, because the government will be insuring their debts. And because the government is backing the companies, they will continue to buy and sell home loans.

Some analysts, however, have doubted the move's effect.

Given the enormity of housing's decline in the United States where prices have seen a fall of about 20 percent from their peak in 2006 and the rise in the supply of homes for sale boosted by building boom and pessimism on house appreciation, some said the federal takeover was not enough to halt the decline in home prices in a short time.

They also said the success of the move depends partly on whether it could draw capital from both domestic and foreign sources.

As the U.S. government is already witnessing a mounting fiscal deficit and the country as a whole has a current account deficit, a commitment of the government balance sheet must be supported by other capital inflows.

Only when such capitals are crowded in, the market can be stabilized and the prospect for a U.S. economic recession can be eased to some extent.

Also as the plan failed to address the question of whether the companies will be nationalized, privatized or kept as government-sponsored enterprises, the companies' long-term prospects remain unclear and investors' confidence would be unlikely to be fully restored simply with the takeover.


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