Will, Freddie and Fannie

Today's news that Freedie Mac and Fannie Mae might be going even further off the rails than previously thought reminds me of something.

America's two largest mortgage finance houses need to raise as much as $100bn ($53.8bn) to cover potential losses as a result of the continued decline in the US mortgage market, a banking analyst has claimed.

The staggering suggestion is the largest published to date by any industry analyst as to the size of the possible funding shortfall at Fannie Mae and Freddie Mac, which own or guarantee $5,000bn of American mortgages, some 70pc of the market.

Shares in the two mortgage groups fell to 18-year lows yesterday on increased concerns that the US government will now be forced to lead a bail-out in order to prevent the mortgage market from becoming destabilised.

Now what was it? Ah, yes, this is it. From Will Hutton all the way back on June 22.

So what public intervention is needed? The US provides the answer. In these conditions, central banks slash interest rates despite what is happening to oil prices; the risk of a credit implosion is vastly higher than an upward wage and price spiral. Also, the US has only been able to avert disaster in its mortgage market via the guarantees offered by two huge public mortgage banks - Fannie Mae and Freddie Mac - which directly or indirectly have provided 80 per cent of all new US mortgages over the last six months. Together, they guarantee more than half of the US's £5 trillion of mortgage debt.

In the US, a bank has the safety valve of being able to turn to one of the public mortgage banks which will either buy or, in effect, insure the mortgage and so keep mortgages flowing in bad times. Without them, the US would have suffered an even bigger house price crisis. In Britain, our banks and building societies have no such safety valve and are paralysed. Nor is any immediate relief promised by lowering interest rates. Instead, Bank of England governor Mervyn King threatens a rise.

We are looking disaster in the face. A British version of Fannie Mae and Freddie Mac must be created now. Legislation to create a Gordon Mac should be introduced before the summer recess. It should be operating by the end of September. Nor is this just an economic gambit. It will be opposed by the Conservatives as an 'anti-business' public intervention. They are wrong. The only way out of this crisis is to embrace the politics of public purpose rooted in the economics of Keynes. Mr Brown has an opportunity to restore the housing market, the economy and his political fortunes. He must act.

Amazing really, how, umm, prescient Hutton is, isn't it?

One purpose, perhaps the pre-eminent purpose, of financial markets is to shift, to disperse, risks. We can, via the intermediation of those markets, buy one millionth of the risks of BP, one ten millionth of the risks that the US Treasury will go bust. Or we can buy bonds in pools of mortgages, taking one millionth perhaps of 50,000 different mortgages.

But it's that dispersal, spreading, of risk which is the aim. FM and FM are of course running the other way around. While they do indeed pool mortgages and then slice and dice them to sell on, the risk is, as we can see there, concentrated in them.

So Will's answer to excessive risk concentrations is that we should concentrate risk more.

Ho Hum.

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