Secty of the Treasury Paulson said then that Washington would buy up shares in the two companies and underwrite their ballooning debt ($800bln). The two companies have lent or underwritten about $5.3 trillion of the total $12tn of all outstanding mortgage debt. Something like 4 million homes or 9% of all existing mortgages were behind or in foreclosure

McCain gave it his immediate backing but Obama said he would reserve judgment. Obama said " We have to protect taxpayers and not bail out the shareholders and management". Obama focuses on a good point, its not just the real estate industry that tanks on this but all those 401K programs funded with Fannie and Freddie stock. Its just a shame.

Whats the Strategy

The move will also replace the chief executives of both Fannie and Freddie. The stocks were up modestly on the news, meaning that investors have voted up, but certainly are lacking enthusiasm. The Treasury will buy up to $100 billion in each company to ensure a cash infusion and maintain a positive net worth. It will also buy mortgage-backed securities from the firms in the open market. Hopefully that will put a floor under the shares....its not possible for them to go completely belly up or get de-listed.

One of the problems that led to the Govt taking it into conservatorship was an accounting trick that was unacceptable. Normally, assets of these two companies were marked to the market every 90 days. Meaning that the asset was given a fairly current and accurate value. Fannie and Freddie changed the rules and decided to mark to the market every two years trying to wait out the crises without having to admit they my be insolvent and further freaking us out. The bottom line is they didnt have the capital base they claimed they had and couldnt continue to buy loans to keep other lenders in the game.

When big banks make home loans, they sell them to Fannie and Freddie, who then package and resell them to investors, or hold them themselves. Now there will be tens of thousands more loans in question...even more defaults and foreclosures then we thought.

Global Problem Now

The rise of the securitization market means some of the most debt securities backed by riskier loans have made their way around the global banking system. That is why this is a global problem. The American financial system was once rock solid and we drew investors from around the globe. Now its different. For example, the Bank of China said in late August that it cut back its portfolio of the Fannie and Freddie's debt by about one quarter since the end of June. The US had little choice after discovering the accounting smoke screen. After all, this is the reputation of the US Govt and its solvency cannot be put in doubt.

Thanks for Reading

Howard Bell

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