THE US government has taken over mortgage giants Fannie Mae and Freddie Mac, promising to pump billions of dollars into the companies to avert a collapse that could trigger a global financial meltdown.
The takeover is the single largest government intervention in financial markets since Fannie Mae was created in 1938 with a mission to facilitate home ownership as part of US president Franklin D Roosevelt's "New Deal".
The move is likely to wipe out the combined market value of both companies, which stood at $10.8 billion (€7.58 billion) at close of trading on Friday, and significantly affect the value of the companies' $36 billion (€25 billion) of preferred shares.
US treasury secretary Hank Paulson said yesterday that the companies, which hold or guarantee more than $5 trillion in mortgages - almost half the total owed on American homes - were too big to be allowed to fail.
"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," he said.
"A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance."
The deepening crisis in the US housing market has seen mortgage defaults and repossessions soar as rising interest rates and plunging property values prompt more Americans to walk away from homes they cannot sell or refinance.
Fannie Mae and Freddie Mac do not offer home loans to consumers but they buy mortgages, sometimes repackaging them for sale to investors and sometimes holding them. They have suffered combined losses of nearly $14 billion in the past year as their share price has tumbled by 90 per cent and large holders of their debt, including foreign central banks, have become increasingly nervous about their financial health.
Yesterday's move puts them in a conservatorship that allows their shares to keep trading but puts common shareholders last in any claims. The US Treasury will immediately take $1 billion equity stakes in each company that could grow to as much as $100 billion each and would be senior to both existing preferred and common shares.
The chief executives of both companies have been dismissed and the Federal Housing Finance Agency (FHFA) will operate the companies until they become more financially stable.
"As house prices, earnings and capital have continued to deteriorate, their ability to fulfil their mission has deteriorated. They have been unable to provide needed stability to the market," FHFA director James Lockhart said yesterday.
Mr Paulson acknowledged that many of Fannie Mae and Freddie Mac's troubles have been caused by the pursuit of higher shareholder value, "which historically encouraged risk-taking".
He pointed out that, although the new plan does not eliminate the existing common and preferred shares, it means they will absorb any losses ahead of the government.
"With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers," he said.
Republican presidential candidate John McCain said he supported the Treasury's move but added that the two companies needed more oversight and better regulation.
"I think that we've got to keep people in their homes. There's got to be restructuring, there's got to be reorganisation, and there's got to be some confidence that we've stopped this downward spiral," he said.
Democratic nominee Barack Obama agreed that some government action was necessary but reserved judgment on the Treasury move before he studied the details of the plan.
He said the plan must focus on "strengthening our economy and helping struggling homeowners who are also being hit by lost jobs, stagnant wages and spiralling costs of everything from gas to groceries".