There was more bad economic news last weekend, with the announcement that Henry Paulson, the US Treasury Secretary, and Ben Bernanke, the Chairman of the Board of Governors of the US Federal Reserve, were stepping in to support the two largest mortgage lenders in the USA, Fannie Mae and Freddie Mac.
Fannie (FNM) and Freddie (FRE) are Government Sponsored Enterprises (GSEs), set up to originate mortgages to American people wanting to buy houses. Because of their status as GSEs, their debt was implicitly backed by the US Government, though this backing seems to now be explicit.
However, they were also able to borrow money themselves at lower rates than the general market, meaning they could make larger profits on the mortgages they lent. A statistic I read today said Freddie Mac had $1 in equity for every $50 it holds in assets (which includes mortgage securities). That’s a lot of debt to be repaid, particularly when you consider the trouble Americans are having right now repaying the mortgages they took out, and also when you consider the falling value of the properties used as collateral for those mortgages should they need to be sold to cover the loans.
The subprime woes of the United States, coupled with the high amount of leverage used by banks originating loans, have beaten down financial stocks this year. I do believe that these stocks will recover, but I suspect this recovery isn’t going to start until at least 2009. There’s likely to be more bad news and further writedowns and losses before the recovery starts.