cryptogon.com

Rumours swamped financial markets on Friday that the US Government would be forced to step in to aid the mortgage finance giants Fannie Mae and Freddie Mac, which together own or guarantee $US5 trillion ($5.16 trillion) in US home loans.

In Wall Street’s version of a run on the bank, investors drove Fannie Mae and Freddie Mac shares to 17-year lows, signalling a gnawing lack of faith in the companies’ ability to survive rising mortgage defaults without the Government’s help.

Later on Friday regulators took over IndyMac Bank of Pasadena, saying the $US32 billion lender had collapsed under the weight of bad home loans and withdrawals by spooked depositors. It was the second-largest bank to fail in US history.

Friday’s events were felt around the world, knocking the battered US dollar lower and driving up interest rates.

“This is a flare-up in the financial forest fire that is far beyond anything we’ve seen before,” said Christopher Low, chief economist at the investment firm FTN Financial in New York.

It is triggering worries that would have been unthinkable even a year ago, including that the US Treasury’s debt might lose its AAA credit grade because of heavy blows to the nation’s fiscal health from the housing mess.

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In 2002 weary investors were hit by a wave of corporate accounting scandals. They simply felt they could not trust what many companies were telling them about their sales or earnings. Share prices dived further.

This time the crisis of confidence is in the US banking system. Fearing more severe losses than they have already suffered, investors in recent weeks have fled stocks of some of the US’s biggest financial institutions at a pace that has stunned Wall Street. Last week they turned with a vengeance on Fannie Mae and Freddie Mac.

Despite the companies’ assurances that they had adequate capital cushions against surging defaults on the mortgages they own or guarantee, the market does not believe them.

For the Government that poses a quandary. Because of their size and importance to the mortgage market, it is inconceivable that Fannie Mae and Freddie Mac would be allowed to fail. But an outright takeover of the companies by the Government, as some experts have suggested, could frighten foreign investors – who are big lenders to the Treasury – by in effect adding the companies’ $US5 trillion debt load to the Treasury’s already substantial debt.

Nationalising the companies “would put the full faith and credit of the Treasury at risk”, said Allen Sinai at Decision Economics in New York.

“It would make foreign investors think hard about buying US Treasury debt.”