Jeremy Warner's Outlook: Calamity as distressed US mortgage companies head for the buffers

Could this be the big one? All market firestorms require a defining, cataclysmic event to mark the bottom and establish a floor from which confidence can rebuild. Northern Rock, in international terms a smallish, regional mortgage bank, was never likely to be it. Personally I thought Bear Stearns might be, but that too has proved insufficient an explosion to put out the flames.

Now Freddie Mac and Fannie Mae, which together account for more than half of all domestic mortgage finance in the US, are teetering on the brink, forcing the White House to consider "conservatorship", or to use the British expression, nationalisation, to prevent complete meltdown in the US housing market.

Hank Paulson, the US Treasury Secretary, insisted in a statement apparently designed to discourage talk of an immediate government bailout, that his intention was to support the two companies "in their current form".

If this sounds familiar, it is because it is the same sort of language that was used by our own Chancellor, Alistair Darling, in the run-up to nationalisation of Northern Rock. Right up to the last moment, the UK Government was trying to avoid outright nationalisation by finding a private-sector solution.

Mr Paulson will likewise be desperate to avoid the blow to reputation and confidence involved in taking these two companies into national ownership. Yet, in the end, he may have no option, for however embarrassing conservatorship might be, it won't be half as bad as the damage that would be done if these two linchpins of the US mortgage market were allowed to go to the wall. Deprived of its biggest source of mortgage finance, the US housing market would collapse, economic confidence would evaporate, and the losses currently being sustained on mortgage-backed securities would be multiplied many times over.

Ironically, Fannie Mae was born out of the Great Depression, when it formed part of President Roosevelt's New Deal. Its demise might very well plunge the country back into it again. It therefore cannot be allowed to fail.

This week's meltdown in the share price was sparked by remarks from Bill Poole, former president of the Federal Reserve Bank of St Louis. According to his analysis, Freddie Mac's liabilities in the first quarter exceeded the current value of its assets by $5.2bn. In the context of such a vast loan book, this might not seem very much, especially as it is based on fair value accounting. In fact, both organisations tend to hold their mortgages to maturity. Even so, accounting for these mortgages at today's market prices suggests Freddie Mac and Fannie Mae either need more capital or have to be bailed out by the government. This has put the share price into a tailspin, making it ever harder to raise the required new equity. Yet if the alternative is complete wipeout in a nationalisation, it makes sense for existing shareholders to mount some sort of rescue. We'll see.

If it does come to conservatorship, the direct impact on the US government will be more apparent than real. The bonds issued by Freddie Mac and Fannie Mae in lieu of the mortgage books they acquire already carry an effective government guarantee. Nationalisation would mean only giving substance to what is already implicit. All the same, it would be a further blow to America's already damaged reputation for efficient, well-regulated capital markets.

The read across to Britain is this. The UK mortgage market, the second largest in the world after the US, has for many years now been highly dependent on funding from international money markets.

Even if Britain's entire stock of retail deposits were devoted to mortgages, they would still be insufficient to fund the gigantic size of the country's mortgage market. The market in mortgage-backed securities has been effectively closed for the best part of a year now, which explains the current mortgage famine and the increasingly severe correction to house prices. To reopen them quickly enough to prevent economic contraction, the UK Government might have to consider something similar to the Federal guarantee that exists in the US.

The adjustment going on in UK house prices is no doubt a necessary one after the long boom. But just as in the US the authorities are not prepared to let Freddie Mac and Fannie Mae go under for fear of what this would do to the wider economy, the same may be true in Britain. If the Government lets the housing correction spiral out of control, who knows where it might end.