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It is looking inevitable that the US government will have to step in to save Fannie Mae and Freddie Mac, the two US government-endorsed secondary mortgage players. Although share prices stabilised towards the end of last week, they still fell 40% in the week and 80% since the start of the year as investors bailed out in the expectation that the shares will be worthless if taken over by the government. The crunch will come at the end of September when apparently both Fannie and Freddie have to raise and roll over $225 billion of mostly short-term debt. If either of them fails an immediate government rescue will be needed and that will leave a lot of US and foreign banks and investors with considerable further write downs.
US banks and insurers hold much of Fannie and Freddie’s $36bn of outstanding preferred stock and this value could be wiped out if the government has to rescue the two. So far, we believe, only JPM Chase has written down any of its investment (it announced last week that it had halved the value of its $1.2bn investment). No other banks appear to have written down any of the current $28bn short fall on these preferred shares, and this, coupled with existing losses on residential construction loans and home mortgages, could be the final straw for many investors. US players are not the only ones who will lose. Three major Chinese players - China Construction Bank, ICBC and CITIC Bank - have disclosed that they hold S7bn in Fannie Mae and Freddie Mac securities.
Last week ex-IMF economist Kenneth Rogoff warned that a major bank failure was in the pipeline and warned the markets to expect a big bank failure in the near future. Lehman’s must be one of the favourites for this forecast, and it is not known how much exposure they have to Fannie and Freddie, but a series of smaller failures in US regional banks could leave other large banks vulnerable through further share valuation and loan write-offs.
Could it be that saving Fannie and Freddie, essential given their crucial role in US domestic mortgages, will start a domino effect which could be the one that brings down the next big player? The US fed and the SEC will be studying their options this week. And where does this all leave the UK government’s expectation that Northern Rock will recover its value and not cost the UK taxpayer up to $4bn?
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