Is it only confidence thatAAEs needed?

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As panicked investors pushed US mortgage finance giants Fannie Mae and Freddie Mac to the brink, debate swirled on whether the meltdown was a crisis of confidence or the onset of wider economic woes. The two government-chartered, shareholder-owned giants underpin some $5 trillion in home loans, and the meltdown in shares this week raised fears of a government bailout, or a possible worsening of the credit crunch. In highly volatile trade on Friday, shares plunged some 50 per cent for both firms before a partial recovery. Freddie Mac ended with a loss of three percent and Fannie was down 22 per cent, but both have lost around 75 per cent since the start of the year.

Brad Sorenson, analyst at Charles Schwab & Co said the companies "affect a much wider swath of the economy than just a typical financial institution, such as Bear Stearns," and that any hint of failure would be "devastating to the US, and indeed the global, financial markets". The troubles intensified as the New York Times reported the administration of President George W Bush was weighing placing one or both companies in a conservatorship to protect them from the snowballing US housing market crisis. Under a 1992 law, if either is seen as being severely undercapitalised, it may be placed into government conservatorship. The two firms said in separate statements they were "adequately capitalised" and had ample liquidity despite swirling market fears. The Freddie Mac statement said speculation around the issue of conservatorship "does not accurately reflect the facts. Freddie Mac is not on the threshold of conservatorship because we are adequately capitalised".

Fannie Mae said: "As we work through this tough housing market, we are maintaining a strong capital base, building reserves for our credit losses, and generating solid revenues as our business continues to serve the market. We also have access to ample sources of liquidity, including access to the debt markets." Freddie Mac has a loan portfolio of $1.5 trillion and Fannie Mae's is over 700 billion. Together they own or guarantee some $5.2 trillion in loans, or about 40 per cent of the total value of home loans in the United States.Treasury Secretary Henry Paulson, in a statement, offered no indication of any imminent intervention. "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission," Paulson said. Senator Christopher Dodd said meanwhile the Federal Reserve was considering opening its discount window, which had been used for troubled banks. Paul Krugman, a Princeton economist, said in a New York Times blog that the government will be forced to come up with a rescue plan. "Big financial crises always end with an expensive bailout of the banking system," he said.

"It happened in Sweden, it happened in Japan. Why should we be different? Except that in this case banks proper took on very little of the risk; Fannie and Freddie, on the other hand, took on a lot of it." Joel Naroff, an economist at Naroff Economic Advisors, said the two entities are being hurt by investor panic about their future prospects. "It's an environment when the financial markets are so weak, investors would rather sell first and ask questions later," he said. Jerry Howard, chief executive of the National Association of Home Builders, lamented the "hysteria" over the viability of the firms. "Pundits who have questioned the viability of Fannie and Freddie are not operating on a factual basis, unnecessarily inflaming market fears," he said. One brokerage note this week said the two firms may have to raise tens of billions of dollars in fresh capital under new accounting rules to offset massive losses in their home loan portfolios.

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