Markets Plunge in Fresh Us Housing Crisis

A deepening housing crisis in the US, escalating oil prices and fears that retailers, holiday companies and banks face a bleak future dragged down stockmarkets on both sides of the Atlantic yesterday to levels not seen since last year.

Declines in the value of Britain's top 100 companies reached more than 20% since their peak, heralding the start of a bear market and sustained selling not seen since the stockmarket collapse of 2003.

Wall Street's concerns centered on the twin mortgage groups Fannie Mae and Freddie Mac and concerns that American families faced a further squeeze on their spending after oil prices rose to a record $147 a barrel.

Fannie Mae and Freddie Mac, which have been deserted by investors since the sub-prime lending crisis hit last year, account for almost three-quarters of new home loans in the US.

US Treasury secretary Hank Paulson was forced to issue a statement in support of the two institutions amid fears that one or both were technically insolvent. He is coming under increasing pressure to back a Northern-Rock style nationalization to resolve the current uncertainty, but has so far baulked at plans to take some or all of the estimated $5trillion (£2.5tr) of assets on to the government's books.

Despite Paulson's reassurance, shares in the two mortgage firms slumped more than 26% and dragged down other US lenders including Washington Mutual, which itself was the subject of a rescue in May. The Dow Jones Industrial Average plunged more than 2% by midday to below 11,000 for the first time in two years.

Britain's top share index tumbled 2.7% to hit its lowest closing level in nearly three years, as concerns deepened that continuing oil price rises could make high inflation a permanent fixture.

The FTSE 100 closed down 145.2 points at 5,261.6, for a weekly loss of 2% - marking an eighth consecutive week in retreat.

Richard Batty, global strategist at Standard Life Investments, said: "If inflation is cyclical then it allows the Bank of England to consider cutting rates ahead of an expected drop over the next two years. But if inflation looks like becoming structural then that is a worry. The Bank of England won't be able to cut rates, workers will ask for higher wage rises and the situation will deteriorate."

Angus Campbell, head of sales at Capital Spreads, said: "The movement this afternoon was a clear indication that we haven't reached the bottom and the bears are still fully in control."

Royal Bank of Scotland, Barclays, HSBC, HBOS, Lloyds TSB and Standard Chartered lost between 1.9% and 7.8%. RBS, which has struggled to sell assets to assist its capital raising program, was the worst faller in the leading index as investors signaled an almost complete lack of confidence in the board's ability to steer out of trouble.

British banks have faced criticism for excessive lending at home and buying sub-prime mortgage assets abroad.

US banks are also in trouble after a sharper collapse in house prices and higher repossessions than anything so far experienced in Europe.

"It's the worst of both worlds," said Matthew Kaufler, portfolio manager at Clover Capital Management in Rochester, New York, which oversees $2.7bn. "Watching two government-sponsored entities evaporate before our eyes from an equity perspective, and the damage that does to investor confidence on the one hand, and watching the price of oil, which is clearly meaningful from a consumer and business perspective, continue to escalate upward creates other pressures."

Paulson said he would allow Congress to consider how best to rescue Fannie Mae and Freddie Mac. He said: "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form. We are maintaining a dialog with regulators and with the companies."

Democrats in Congress are supporting measures for a $300bn (£150bn) refinancing package of sub-prime mortgages, in exchange for getting banks to write off much of their borrowers' debts.

Fannie Mae and Freddie Mac should play a large part in the mortgage rescue, which would allow low income families to remain in their homes and stave off a steep rise in repossessions.

But the project has been undermined by reports that new accounting rules will force the two institutions and other lenders to put back on their balance sheets more than an estimated £3.5 trillion in total assets now sitting in off-balance-sheet vehicles.

Loan backers

Fannie Mae and Freddie Mac are sponsored by the US government, but owned by shareholders. They buy mortgages, package them into securities and sell them on to investors. They stand behind three-quarters of all new US mortgages. The Federal National Mortgage Association, nicknamed Fannie Mae, was created during the Great Depression of the 1930s to ensure sufficient funds were made available to mortgage banks. In 1970, the Federal Home Mortgage Corporation, nicknamed Freddie Mac, the country's second largest mortgage lender, was created.