US Housing Crisis: Freddie and Fannie Are Nationalised

Financial markets are forecast to react favorably today to the US government's move to take mortgage lenders Freddie Mac and Fannie Mae into temporary public ownership, ending the uncertainty that has surrounded the two institutions for several months.

The FTSE 100, which fell sharply last week on fears for the health of the British economy, is likely to bounce higher in early dealings on relief that the US government has stepped in to stave off the possible collapse of the two lenders, which have lent or guaranteed nearly half of the US' $12tn (£7tn) of mortgage debt.

"I think the stockmarket is going to take this as a positive," said William Larkin, of Cabot Money Management in Massachusetts. "The government is going to be pulling a lot of this stuff on to [its] balance sheet and that may be a concern for the dollar but it is going to be a positive for our financial system."

Peter Kenny at Knight Equity Markets in New Jersey added: "It's probably a good move for the markets in the short term. [But] it's not going to address declining house prices."

The US treasury secretary, Henry Paulson, when announcing the move into "conservatorship", as temporary nationalization is known in the US, reminded the world how important the two companies are: "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 at home and around the globe."

Freddie and Fannie have run up debts of some $1.6tn over the past year as a result of falling house prices and rising mortgage defaults. Paulson announced in July that the government would begin buying shares in the two companies and guarantee their loans but the latest step had also been widely expected.

Paulson denied, however, that the move would cost taxpayers billions: "Federal Housing Finance Agency [FHFA] and the treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible."

The FHFA, which was formed in July from three former housing regulators to take control of the mortgage crisis, will run the two institutions.

Paulson said the executives and board of directors of both lenders had been replaced. Herb Allison, a former vice-chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice-chairman of US Bancorp, was picked to head Freddie Mac.

Paulson said shareholders, who will be left with only a small share in the business, will be expected to absorb any further losses before the taxpayer becomes liable. He added that all voting rights would switch to the government and 80% of the common stock "on a fully diluted basis at a nominal price". Analysts said the combined effect of these policies would in effect wipe out the value of any existing shares in the lenders.

Though house prices in some parts of the US appear to be bottoming out after more than two years of falls, analysts warned that the housing market is not yet out of the woods.

"Mortgage delinquencies continue to set new records, promising more losses and future write-offs for banks and other mortgage lenders," said economists at the investment bank Dresdner Kleinwort.

"The problems are spreading from the sub-prime sector to prime loans, particularly to mortgages with adjustable rates and optional payment features. With unemployment rising faster, cyclical problems will now compound the damage caused by falling house prices."