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U.S. government offers to recover mortgage market
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16:02, September 09, 2008

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The United States government announced on September 7 the historic takeover of the country's two mortgage giants Fannie Mae and Freddie Mac and at the same time to dismiss the top executives of both companies. Under the plan, the U.S. Treasury will provide capital needed by the two mortgage firms to avert their bankruptcy and initially purchase one billion U.S. dollars in priority shares in each of the firms.

The U.S. government has intervened on such a large scale to back up the private market, and this is aimed to stop for a short duration the two firms from collapsing and avert a major financial turmoil in the U.S. and upheavals in the global banking market, according to public opinions. But its long-term effect awaits further observation.

The historic takeover by the Bush administration of the ailing mortgage companies Fannie Mae and Freddie Mac, the two biggest U.S. mortgage firms, has not come as a surprise after all. With Fannie Mae and its sibling company Freddie Mac more risk averse, fear are building that mortgage rates will keep climbing. The two companies have reported losses for four consecutive quarters (Their combined losses of nearly 14 billion dollars in the last 12 months have aroused wide concerns over their sustainability in the business) and their loss in the second quarter of 2008 alone reached close to 2.9 billion dollars, exceeding their original market forecast by three-fold.

Fannie Mae and Freddie Mac, the two largest mortgage companies, whose capital account for more than half of the 12 trillion US mortgage market, occupies a crucial position in U.S. economy. It was established on the basis of Congress legislation and to ensure the fluidity of U.S. mortgage financing market with a dual objective for the public and private purposes. They are private firms aimed at making profits on one hand and, on the other hand, they undertake to help many people and ethnic minority groups in particular to own their own homes.

These two firms play a critical and increasingly dominant role in the mortgage market. They buy mortgage loans from banks and package those loans into securities that they either hold or sell to U.S. and foreign investors, so as to attract or enable banks to release more mortgage loans. To date, the two companies' performance is crucial to the U.S. mortgage sector as they own or guarantee almost half of the country's total 12 trillion U.S. dollars in outstanding home mortgage debt.

Against this backdrop, landmark housing legislation sailed through the House in late July. The bill, which passed overwhelmingly through the House 55 to 10, gives the U.S. treasury the power to inject emergency capital, or government funds, into the two mortgage giants when necessary.

Nevertheless, the government's earlier indication to rescue Fannie Mae and Freddie Mac has, as a mater of fact, not helped to resume the market confidence. In the past two months, the U.S. mortgage market deteriorated and losses of the two mortgage firms, Fannie Mae and Freddie Mac, continued to rise. What making the matter ever worse is that some banks have reduced their amount of securities in stock, so the cost of financing or borrowing for Fannie Mae and Freddie Mac greatly increased.

The structural problem of the two U.S. mortgage firms poses the fundamental cause for their economic risks, according to consensuses reached by numerous economists, who advocate for nationalizing Fannie Mae and Freddie Mac and turning them into smaller companies after the property market revives. The Treasury's present plan for capital (or government fund) injection is apparently between the nationalization and marketization.

As rewards for its capital inflow, the U.S. government will not only purchase priority shares for a return rate at above market interest rate, but also buy up to 80 percent of ordinary shares from each of the two companies at the nominal price of less than one dollar per share. The treasury, however, has prepared to purchase, when necessary, up to the 100 billion dollars of priority shares to compensate its future losses. The move implies that Frannie Mae and Freddie Mac would be able to maintain their normal operation with taxpayers'money.

The Fannie and Freddie rescuestate seizure by the U.S. federal government is designed to rescue the mortgage market and economy as a whole. Stock market would possibly make an active response accordingly in a short period of time, according to economic analysts, but it is still difficult to predict whether it will be able to reverse a downward trend in the U.S. housing market.

By People's Daily Online, and its author is PD resident reporter in U.S. Ma Xiaoning

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