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US mortgage lenders, Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are both teetering on the brink of disaster as their ability to remain solvent is questioned and their share prices plummet. Lehman’s shares have dropped 80% this year on the back of sub-prime mortgage writedowns. Washington Mutual, Countrywide and Indy Mac are all sub-prime lenders facing acute liquidity problems. Is the US banking market about to fall further?
Former International Monetary Fund chief economist, Kenneth Rogoff has warned that a major bank failure is in the pipeline. Speaking at a conference in Singapore the now professor of economics at Harvard said “The US economy is not out of the woods. I would even go further to say 'the worst is to come'. We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks." Rogoff does not believe that Fannie Mae and Freddie Mac will exist in their current forms for much longer.
Fannie Mae and Freddie Mac are both US government sponsored (but not owned) enterprises that operate in the secondary mortgage market and provide liquidity to these markets. Between them, they own or guarantee about half the US’s $12 trillion mortgage market. Their shares dropped 20% yesterday alone and have fallen to nearly one fifth of their value since the beginning of July. With the increasing likelihood that the US government will have to bail out these two organizations and that this could render the shares worthless, shareholders have been jumping ship as fast as they can find a buyer. Investor confidence must be at rock bottom.
Lehman’s have written down $8 billion already in sub-prime mortgage losses and they are forecast to write off another $4 billion. Share prices are down to under $14 valuing the bank at $9.5 billion against $61 billion in further mortgage exposures. Could Lehman fulfil Rogoff’s prophecy?
Despite positive noises coming from some quarters and a strong “can do” attitude from US bankers, investors and public, there must be serious concern that significant bank failures are imminent and there is a limit to how much the US government and its central bank can bail out these casualties. How will this affect other global markets?
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