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US Subprime: Government Bailout and its Effects

Posted by Manish Agrawal on Wednesday, 10 September, 2008

The US government has announced its bailout of Freddie Mac and Fannie May. How will this affect markets?

Between them, Freddie Mac and Fannie May have $5.4 trillion of mortgage-backed securities and debt outstanding. They had an 80% market share of new mortgages in early 2008, although this figure is now dropping.

But over the past year or so, as the US property market has declined, their capital has been less able to soften the effects of additional losses – while simultaneously sustaining new business. These US mortgage issues have had far-reaching effects on global markets, and can be partly to blame for the enduring inflation in the US and abroad. (See our Sep. 2 article, “US Economy: GDP Increase of 3.3% – What does it Mean?”) Together, they have had a loss of around $14 billion in the past year.

So the question now is, are we back on track, or at least moving in the right direction to correct the US lending woes? Key indices in Japan, Korea, Hong Kong, Singapore, Taiwan, and Australia were all up just a day after the announcement.

But this good news wasn’t enough to have much of a positive effect on China’s indices. The Shanghai Composite index dropped more than 2 percent due to domestic losses, in sectors such as airlines and property.

CNN quoted the head of the Australia’s central bank, Glenn Stevens, as saying, “I think what the American authorities have done, in the brief look I’ve had, it is the right thing. Their implications are likely to be positive for markets because it’s a source of uncertainty close to resolution.”

The Federal Housing Enterprise Oversight director James B. Lockhart, said in a 7 September press release that Freddie Mac and Fannie may, “…cannot continue to operate safely and soundly and fulfill their critical public mission…” without addressing certain concerns.

The concerns listed included capitalization issues, the present market conditions, overall financial performances of the two companies, the incapability of each company to adequately fund themselves as per normal procedure, and the vital importance each company has in backing the American residential mortgage market.

Lockhart also said that, “The goal of these actions is to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, and mitigate the systemic risk that has contributed directly to the instability in the current market.”

If the recent Asian market gains are anything to go by, Lockhart may in fact be restoring this confidence. And if US markets can see the light as well, we may well be on our way back to some sense of normalcy in the US mortgage market.

Santos de la Raya, EconomyWatch.com

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