Global shares have rallied after the US government said it was taking over troubled mortgage lenders Freddie Mac and Fannie Mae.

Investors hoped the largest bail-out in US history would prop up the country’s housing market and ultimately help to end the credit crunch, analysts said.

On Wall Street, major shares added 2.58% in trading while key European and Asian indexes were up by at least 2%.

President Bush said the firms had posed “an unacceptable risk” to the economy.

Solvency bid

In a dramatic move, US Treasury Secretary Henry Paulson announced the rescue plan on Sunday, before markets opened.

FREDDIE MAC & FANNIE MAE
The two firms:
Buy mortgages from approved lenders and then sell them on to investors – rather than lending directly to borrowers
Guarantee or own about half of the $12 trillion US mortgage market
Are relied on by almost all US mortgage lenders
Are looked to for funds to meet consumer demand for mortgages
Link mortgage lenders with investors – keeping the supply of money widely available and at a lower cost
Have no direct UK equivalent

Q&A: Freddie Mac and Fannie Mae
The importance of Freddie and Fannie

Between them Freddie Mac and Fannie Mae finance or guarantee nearly half of the outstanding mortgages in the US, and have lost billions of dollars during the US housing crash.

Much of their bond debt was ultimately held by Asian banks, who had recently begun withdrawing their investment.

The most recent figures show that about 9% of US mortgage holders were behind on their payments or faced repossession.

The rescue could cost the Federal government $200bn (£100bn) as it invests fresh capital into the stricken mortgage giants to keep them solvent.

But a collapse of the two lenders would have frozen US mortgage lending for years, and would likely have lead to even steeper declines in house prices.

According to one widely-reported index, US house prices are falling at an annual rate of more than 15% in major metropolitan areas, putting many people in negative equity.

Shares rally

The rescue plan reassured investors worldwide who feared that a collapse of the government-sponsored enterprises could have a ripple effect on financial markets, with further losses by major banks leading to yet further cutbacks in credit and lending.

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On Wall Street, the Dow Jones added 2.58% in afternoon trading – a welcome rally after it lost 4% last week.

Meanwhile in London, FTSE 100 index was 3.92% ahead at close after a technical glitch had brought trading to a halt for much of a day.

It had lost 7% last week – its worst showing in more than six years.

UK banking stocks had been buoyed by the news from the US, some adding as much as 15%. House builders also gained on hopes that the move could signal a turnaround in the sector.

Germany’s Dax-30 index was 2.22% ahead at close and France’s Cac-40 added 3.42%.

Meanwhile Japan’s Nikkei index closed up 3.4%, while the Hang Seng index added 4%.

US Treasury Secretary Henry Paulson on the reasons behind the government’s decision.
And key indexes in Singapore, Australia and Taiwan were also higher.

On Wall Street, where the Dow Jones index shed 4% across the previous five sessions, there have been positive signs.

The effective government takeover will lead to major changes in how the two mortgage giants are run.

As part of the changes, the management of the two companies will be replaced while the firms will be given access to extra funding to support their business going forward.

HAVE YOUR SAY I have lost both faith and trust in banks
Keith Ridgers, Cobham
Send us your commentsMr Paulson said the government was intervening in the wider interests of the financial system and of taxpayers since the financial position of the two firms was fast deteriorating.

The move is intended to keep the two companies afloat, amid fears that either could go bankrupt as borrowers default on their home loans.

Together, Freddie Mac and Fannie Mae own or guarantee about $5.3 trillion (£3 trillion) of mortgages.

But they have made a combined loss of about $14bn in the past year and officials were worried that they would no longer be able to continue functioning if such losses continued.

Banks around the world are highly exposed to the two companies and therefore, given the febrile state of markets across the world, it had become dangerous for doubts to persist about whether they were viable and would be able to keep up the payments on their massive liabilities, says the BBC’s business editor Robert Peston.

A rescue plan passed by Congress in July gave the US government the authority to offer unlimited liquidity to the two companies, and to buy their shares, in order to keep them afloat.

News reported by The BBC

LONDON (Reuters) – Britain’s battered smaller banks and other lenders are ripe for merging to create a bigger, stronger bank, but fragile markets and a grim economic outlook are likely to delay consolidation until some stability returns.

Bradford & Bingley (BB.L: Quote, Profile, Research), the UK’s largest lender to landlords, is at the sharp end of concerns about smaller banks as it nears a 400 million pound cash call set to be backed by other banks but snubbed by its army of small shareholders as concerns over bad debts deepen.

An acquisition of B&B would solve a headache for regulators and the industry, removing the threat of a repeat of last year’s embarrassing collapse of mortgage lender Northern Rock.

Analysts and bankers say rivals Alliance & Leicester (ALLL.L: Quote, Profile, Research) and other lenders like Paragon (PARA.L: Quote, Profile, Research), Bristol & West (BKIR.I: Quote, Profile, Research), Cattles CTT.L and smaller building societies would all benefit from being pulled together. There are also multi billion-pound closed books of mortgages held by top investment banks that could be included.

Potential buyers or consolidators are watching with interest as valuations plummet, bankers and sources familiar with the matter, but they are not confident enough to pounce yet.

“It’s very difficult to make deals happen because share prices are just so volatile. You could start negotiations and two days later the share price is 20 percent lower,” said James Eden, analyst at Exane BNP Paribas. “And all the banks think they are worth more than the current price.”

The logic for bringing together several of the smaller banks or other lenders would be to cut costs, strengthen their capital base to withstand shocks, improve credit ratings, and reduce funding costs at a time of tough wholesale markets.

The most public move so far has come from entrepreneur Clive Cowdery, who wanted to inject 400 million pounds into B&B and use it to spearhead consolidation of smaller lenders.

News reported by Reuters