The great mortgage bail-out

Pressure is already growing for the US's unprecedented rescue of the mortgage market to be replicated in the UK, despite some concerns about its long-term effectiveness.
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The Independent Online

It took decades for Coca-Cola, McDonald's and Starbucks to make their way over here. It may be only a matter of weeks before the American way of mortgage life, or at least a significant chunk of it, also finds its way to our shores. The rescue of the US mortgage agencies Fannie Mae and Freddie Mac has intensified pressure on the Government and the Bank of England to save our own beleaguered mortgage market with a similar state-backed guarantee – and fast.

Why, more and more players are asking, cannot our authorities end the uncertainty now over the Bank of England's Special Liquidity Scheme (SLS), due to end on around 21 October, and the Government's plans to revive the market for mortgage-backed securities?

Decisions are due in the next few weeks, after the Bank's review of its open market operations and the delivery to the Treasury of the review by the ex-HBOS chair, Sir James Crosby, on mortgage finance. But both could be pre-empted, if the politics were right.

George Magnus, senior economic adviser to UBS, and widely credited with spotting the credit crunch early, vividly describes the nervousness stalking the City.

"If the SLS is going to be shut in October, then we will have a monster problem, in which liquidity problems for banks could end up as a solvency crisis," he said.

"I cannot see the £200bn or whatever of assets, against which the Bank has lent, being refinanced any time in the next three years, and if banks know this, they won't want to wait the full term. So the refinancing is effectively brought forward and there could be a nasty crunch if the assets can't be refinanced.

"My take, then, is that the Bank will have to change its policy, assuming termination in October is the chosen path, for fear of walking headlong into a refinancing explosion."

Political players are equally impatient. John McFall, the Labour chairman of the Treasury Select Committee, said: "There is a new paradigm in this market: Government does have a role to play. This is a full-blown Technicolor nationalisation, and I am in favour of our Government doing something to assist the housing market.

"The Bank of England's Special Liquidity Scheme has helped to protect the real economy. Doing something to assist the housing finance market is important, and it is a question of doing that something without prompting the sort of excesses we've seen in the past, without giving them another burst of oxygen."

The Council of Mortgage Lenders told the Chancellor, Alistair Darling, last week: "We believe that an early announcement of the renewal/extension of the Special Liquidity Scheme and any other measures being planned will help to resolve market uncertainty."

The Bank of England's position is not difficult to discern. On the SLS, they say it will be replaced, but – crucially – the character of the replacement, dubbed "son of SLS", is left vague.

Mervyn King, the Governor of the Bank of England, said in June: "We intend to learn from the experience of the scheme to put in place a liquidity facility that works in all seasons – both 'normal' and 'stressed'. It will be part of a set of reforms to our Red Book." That, to some in the banking world, is simply not good enough.

More worrying for them, though, is Mr King's defiance over the wider notion of the state intervening in the housing finance market. "It would be a very dangerous move to a situation where the Government saw its major role as guaranteeing lending," he said. "Why should the taxpayer take on the risk of borrowing by individual borrowers?"

The Governor has also pointed out the opposition of his counterparts in the US Fed to the "great dangers of offering government guarantees to mortgages".

Given such public resistance to a "very dangerous" scheme, it is difficult to see No 10 going ahead with what many in the banks would like them to; to copy or adapt the US model. The banks argue, for example, that the Government could charge them a commercial fee for guaranteeing their securitised mortgage books, thus restoring confidence in the way the Americans s have.

Yet what would the Governor do? It might be apocalyptic to see Mr King threatening to quit over such a plan, but it is also difficult to see how he can swallow those rather indigestible words. It is also rumoured that the Treasury is sympathetic to Mr King's stance on this issue (if little else). Together the Governor and the Chancellor could thwart an enfeebled prime minister. With the Labour conference starting on 20 September, the politics of the credit crunch are becoming as tangled as the economics. There is more than a feeling abroad that the most explosive dramas are yet to come.

Nor may the sleepless nights be over for US Treasury Secretary, Hank Paulson. The relief on Wall Street was palpable yesterday, but serious questions marks remain about long-term solutions for Fannie Mae and Freddie Mac – and the likely impact for the housing and credit markets of this rescue.

Mr Paulson, the US Treasury Secretary, received praise for his decision. He publicly admitted that the circumstances leading up to the extraordinary takeover of firms that together make up almost half of the $12 trillion (£6.8trn) US mortgage market had "not been a happy time for anyone".

As part of the takeover, shareholders in the two firms faced losses and both their chief executives were removed. "I've never been through any situation which was as difficult, as stressful, as complex," the secretary and former chief executive of Goldman Sachs, said. It was the only time in his life he said when he had difficulty sleeping at nights.

The weekend's historic takeover was made possible by the special authority extended to Mr Paulson by the US Congress in July. At the time, he expressed the hope that a takeover of the two companies would prove unnecessary. But in recent weeks, confidence in their ability to stay afloat has gradually ebbed, and finally Mr Paulson appeared to have little choice but to act.

Their passing into government control had the effect of lifting market sentiment worldwide as investors absorbed the news. Concern that the eventual collapse of Fannie and Freddie would further hurt already stressed financial institutions had contributed to falling share prices around the world.

However, few observers dared predict the rescue of Fannie Mae, created after the Great Depression, and Freddie Mac, established in 1970, would spell the beginning of the end of the global credit crisis. Some had seen the rescue of Bear Stearns last March as a sign that the worst had surely arrived, but after a short burst of euphoria the markets were soon back in the woods.

Nor was there any clarity over what may happen to Fannie and Freddie over the longer term. The two most obvious options remained either to retain them over the long term as nationalised institutions charged with providing financing for the US mortgage market or, as the former Federal Reserve chairman Alan Greenspan has suggested, to break them up into smaller entities and return them to private control.

"This is not a permanent solution – they've not saved Fannie and Freddie, what they've done is they've bought 15 months," said Bill Ackman, founder of Pershing Square Capital Management in New York, which had bet on their decline. "It's a Band-aid. They haven't permanently recapitalised the companies."

Mr Paulson knows the hard decisions regarding their futures will fall well into next year when the US will have a new occupant in the White House and a new Treasury Secretary. The notion that this is a first step towards dismantling both companies might sit well with conservatives and Republicans but was already sounding alarm bells among Democrats.

"This will be a real problem," if the weekend's actions were ideologically driven, declared Senator Christopher Dodd, the chairman of the Senate Banking Committee, saying that historically the two institutions had made America one of the easiest countries for consumers to get mortgages and own homes.

Still to come into view fully last night, meanwhile, was the political fall-out from the decision, which received vigorous day-after support from the White House. Most particularly, Mr Paulson declined to say what the cost would be to taxpayers. The New York Times cited a Congressional Budget Office estimate published two months ago of $25bn, but some experts think the bill could be much higher.

The man to fix the credit crunch?

The options had dwindled, but Hank Paulson's decision effectively to nationalise American's mortgage goliaths, Freddie Mac and Fannie Mae, was nothing if not brave. Republicans are not meant to behave that way. Yet fearlessness has long been associated with the former CEO of Goldman Sachs.

Mr Paulson's interest in poisonous snakes is not a secret – touching and holding them – and nor is his wider love affair with the outdoors. Until he became Treasury Secretary in July 2006, he dedicated much time to ecological conservation causes, especially in Asia.

As a child a farm in Illinois, it was Christian Science that may have influenced him the most, and also gave him connections. An American football player at college, he worked briefly for John Ehrlichman, aide to Richard Nixon, who was jailed for his role in Watergate. Mr Ehrlichman was a devout Christian Scientist. "Christian Science is a religion in which you emphasise love as opposed to fear," he once said, adding, "I think fear in young kids is the biggest inhibitor to success."

Mr Paulson, 62, may always have been destined to serve in government. Before working for Mr Ehrlichman in 1972, he had been an aide to an assistant secretary of state in the Pentagon. Three of his predecessors at Goldman Sachs left to enter government.

Mr Paulson's action might have sat more easily with a Democrat, and Democrats have had to give him credit. "He's done a spectacular job balancing free-market ideology with strong government actions," Thomas Nides, chief administrative officer at Morgan Stanley, said even before the take-over at the weekend. "And as a Democrat that's not an easy thing to say."

David Usborne

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