US Treasury close to deal to prop up mortgage giants Fannie and Freddie

The US Treasury is close to a deal to prop up the mortgage finance giants Fannie Mae and Freddie Mac, whose crumbling finances have put the US housing market in jeopardy and threatened to turn an economic slowdown into a deep recession.

A string of meetings yesterday between Treasury Secretary Hank Paulson, Federal Reserve chairman Ben Bernanke and the chief executives of the two companies were aimed at hammering out a deal that could be announced as soon as this weekend.

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The intensive efforts to reach an agreement came as a poisonous cocktail of fear, financial distress and weakening economic news sent global stock markets skidding lower. The FTSE 100, the UK's premier stock market index, closed out its worst week in more than six years, while the US government admitted that unemployment had surged above 6 per cent in the world's largest economy, taking it back to levels seen in the last recession at the start of the decade.

Meanwhile, rumours of distress among hedge fund investors returned to haunt the markets on both sides of the Atlantic. Funds have been racing to reshuffle portfolios, dropping bets on the euro and the pound and on commodities such as oil, in favour of safer investments such as government bonds.

Last night, the FTSE 100 stood at 5,240.7, down 121.4 and back in "bear territory", down more than 20 per cent from its October peak. There were similar falls across Europe, and the US market initially extended Thursday's big sell-off during the morning hours, before bouncing to end modestly higher. The future of Fannie Mae and Freddie Mac have weighed heavily on markets since the credit crisis began, and particularly since they began posting multi-billion losses this year. The two own or guarantee almost half of all mortgage debt in the US, and their failure would send mortgage rates soaring, prompting another leg down for the US housing market. Foreign governments have also bought close to $1 trillion of Fannie and Freddie's own debt.

In July, when mounting losses threatened to cause a crisis of confidence, Mr Paulson said the Treasury would do whatever it takes to keep the companies afloat, including buying shares or lending money. He won a "blank cheque" from the US Congress to do just that, and the deal being hammered out is said to include "creative use" of the options available.

The Wall Street Journal reported the talks last night. It is understood that senior management changes are likely as part of the deal. A Treasury spokes-man said Mr Paulson had been "making progress" but declined to comment further. The companies declined to comment. US home foreclosures and the rate of homes entering foreclosure rose to record highs in the second quarter, according to figures yesterday from the Mortgage Bankers Association. House prices have been falling at an annual rate of more than 20 per cent in some areas of the country.

Adding to the gloom yesterday, there was an unexpectedly large climb in the unemployment rate. In August, 6.1 per cent of the workforce was without a job, higher than the 5.7 per cent expected by economists. Employers shed 84,000 jobs in the month and earlier months' figures were revised to reflect new, gloomier information. The US labour market has not been so weak since September 2003.

David Resler, chief economist at Nomura Securities, said: "We're running job losses that are typically seen in the early stages of an economic recession. There's no escaping that it's bad news for the economy."

Investors fear that rising job insecurity will cascade through the US economy, hurting already weak consumer spending and leading to a downward spiral in business confidence. To date, the US economy has remained resilient, despite the credit crisis, posting more than 3 per cent growth in the second quarter.

The dollar, however, has rallied in recent weeks, and that upward momentum accelerated this week. Last night, the British pound was worth $1.76, flat on the day but down 3 per cent since a week ago, its seventh weekly decline. But even the euro has been sliding against the dollar, amid fears that a credit crisis that began in the US housing market will now upend economic growth all over the world, with Europe heading most sharply downwards.