Forget Northern Rock. Forget Bear Stearns. The United States Government's decision to nationalise Freddie Mac and Fannie Mae is the single most significant episode of state intervention in the financial markets since the credit crunch began. The American government now takes on to its national balance sheet $5.4 trillion (£3 trillion) of US mortgage liabilities. And the US Treasury will inject at least $200bn into the two companies. It amounts to the biggest corporate rescue in history.
The US Treasury Secretary, Hank Paulson, hoped that the implicit guarantee of funding he made in July would be enough to shore up market confidence in the two giant mortgage lenders. Investors were not convinced. The share prices of Freddie and Fannie continued to fall. And when overseas investors in the two companies began to lose their appetite for new bonds, a state rescue became inevitable.
Freddie and Fannie were, in that dreaded phrase, "too big to fail". If either had been allowed to go bust and default on payments it would have sent a catastrophic shockwave through the American economy. And so many foreign states have invested in the two that this shockwave would have travelled around the world.
But while a rescue became inevitable, it is interesting to note that when Washington finally decided to move, it was prepared to take much more decisive action than our own Government did over the failed mortgage bank Northern Rock. Mr Paulson has wiped out the incompetent managements of Freddie and Fannie and intends to hit shareholders hard. By contrast, our own Government was content to let the hapless management of Northern Rock stagger on for months. And our Treasury was much more humble in dealing with shareholders demanding compensation. The land of the unbridled free market has been rather more radical in using the power of the state to intervene. It is also notable that while the heads of Wall Street investment banks such as Merrill Lynch and Citigroup have been forced out (albeit with enormous payouts) the heads of our own write-down issuing banks have all survived.
Yet we should not make too much of the differences. The truth is that there has been stunning "moral hazard" on both sides of the Atlantic in the past year. Taxpayers' money has been used on an unprecedented scale to inject liquidity into dried-out markets, something which has thrown a lifeline to thousands of greedy investors and irresponsible banking groups that would otherwise have gone bust. The extent of the public liabilities resulting from this crisis, both in America and Britain, will only become clear over time. But we can be certain that they will be vast.
The US government and Federal Reserve have now done – and will continue to do – what is necessary to protect the American economy. Our own Government and the Bank of England will have to follow. That should mean an extension of the Bank's Special Liquidity System to underwrite the issuance of new mortgages. The priority of both of our governments has to be to stop the present slowdown from turning into a depression.
But when it is over, there needs to be a reckoning. The banks that relaxed their lending standards so irresponsibly in the boom must be constrained to stop them doing the same thing again. Those regulators and politicians – amongst them our own Prime Minister – who rode the housing and speculation boom while neglecting to demand sound lending practices must also be held accountable. The credit crunch is not just a market failure. It is a damning failure of regulation.