Between them, Freddie Mac and Fannie Mae – which at the start of this year had over 80 percent market share of all new mortgages – have €3.6trn of guaranteed mortgage-backed securities and debt outstanding. This is equal to the total publicly held debt of the US.

The cash infusion was one of a series of measures designed to restore order to the stricken financial system. Others included the immediate removal of the chief executives of the companies and the elimination of future dividends to shareholders.

Confidence in the two businesses, which account for nearly half of the total €8trn US housing market, has waned as property prices have collapsed and foreclosure levels have soared. Yet despite the credit crunch affecting the sub-prime mortgage market for over a year, the first real signs of US government intervention came in July 2008 when the US Treasury said it would shore up their finances if they needed help in what would be the biggest state rescue in history. Plans approved by Congress in the summer allowed the government to support the two firms by expanding their access to credit and permitting the Treasury to buy shares in the companies if needed. A month later in August, Fannie Mae unveiled that its chief financial and risk officers were leaving ‘to pursue other opportunities’.

But on 8 September, the companies were brought under tight government control in a so-called ‘conservatorship’ – essentially nationalising the businesses. Under this scheme, the government will guarantee the firms’ debts, bring in new management and provide fresh liquidity to make the business less vulnerable to the declining market. This process will take at least a year, and will be highly expensive. According to the Congressional Budget Office, such a move could potentially cost US taxpayers up to €16bn.

The maestro
Henry Paulson, the US Treasury Secretary and a key orchestrator of the rescue package, acknowledged that it was highly unusual for a government to intervene where publicly traded companies such as Freddie and Fannie were concerned. But he emphasised that the two struggling groups represented a special case because their survival was crucial to the health of the worst housing market since the Great Depression of the 1930s.
Announcing the plan in Washington, Paulson said: “It is necessary to take action. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing.”

President Bush said the two struggling companies had posed an ‘unacceptable risk’ to the financial system. “Allowing the companies to fail or further deteriorate would damage our home mortgage market, and could weaken other credit markets,” he said in a statement.

The US presidential candidates have also supported the bailout. Barack Obama said action must be taken to stabilise the two firms “because the housing market, which is already weakened, would be in even worse shape if we didn’t take some steps”. For the Republicans, John McCain said the two firms needed to be reconstituted. “There’s got to be reorganisation and there’s got to be some confidence that we have stopped this downward spiral,” he said.

Some commentators have criticised the prospect of such a giant ‘bailout’ for companies that are privately owned. But the Treasury hopes that taking such action will help to rebuild confidence and stability in the mortgage markets. And the US government is taking no chances. As well as seizing control of the banks, changing their senior management and pledging to inject up to €135bn, it said that it would offer short-term loans on favourable terms to Fannie and Freddie, as well as to 12 so-called federal home-loan banks, which offer low-cost mortgages.

Presently, it is difficult to know how much of the €135bn injection money at the government’s disposal will eventually be used because it plans to provide cash infusions when they are needed, rather than injecting money upfront, based on an estimate.

The collapse of Lehman Brothers
The global credit crunch claimed yet another major scalp when the US’ fourth largest investment bank Lehman Brothers filed for bankruptcy protection after posting a loss of €2.6bn for the three months to August just five days earlier, putting to an ignominious end its 158-year history. It is the biggest corporate bankruptcy in history in terms of assets held: with €433bn of assets, it dwarves Worldcom’s €85bn in assets and Enron’s €54bn in assets at the time of their bankruptcies.

But Lehman Bros was not the only financial giant to rock world markets on 15 September. Fellow US bank Merrill Lynch, also stung by the credit crunch, agreed to be taken over by Bank of America for €33bn. Two days later US insurance giant AIG received a €57bn rescue package from the US Treasury in return for an 80 percent stake in the business. On 18 September UK bank Lloyds TSB announced that it was buying the country’s biggest mortgage lender HBOS in a €15bn deal. More banks and insurers are expected to either go bust or merge by the end of the year.

Lehman fell under the weight of €40bn in soured real estate holdings, and the credit market’s dislocation ultimately forced it to seek court protection. But one bank’s losses is often another bank’s potential gains – and so it has been for Barclays Bank. Barclays had been in talks prior to the collapse to buy most or all of Lehman’s operations (as had rival bank, Bank of America) but pulled out on 14 September. The bank filed for bankruptcy protection the next day, a move that saw its share price plummet by 90 percent and the Dow Jones Index close down just over 500 points – the largest drop in a single day since the days following the attacks on 11 September 2001.

On 20 September a US bankruptcy judge approved the €0.8bn sale to Barclays within a week of its collapse (down from the original €1.1bn due to property price reductions and a fall in Lehman’s trading accounts), saying he had found no better alternative for the assets Lehman sought to sell. “I have to approve this transaction because it is the only available transaction,” said Judge James Peck, adding that “Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets”.