The indispensability of Fannie and Freddie

By James Saft

LONDON (Reuters) - Like it or not, the U.S. economy and financial system just can't live without mortgage behemoths Fannie Mae and Freddie Mac, who are now pretty much all that is standing in the way of a complete collapse in housing.

Concerns over how suggested new accounting rules might force the two government-sponsored entities (GSE) to raise huge and unfeasible amounts of capital touched off a rapid fall in their shares, their bonds and in the mortgage debt they guarantee this week, not to mention in the rest of the U.S. stock market.

Treasury Secretary Henry Paulson and James Lockhart, Fannie and Freddie's main U.S. regulator, both moved to allay concerns, and much of the market damage was unwound.

No wonder. If you consider what the world would look like if they ran into very serious trouble you quickly realise that they are not just too big to fail, but pretty much too everything to fail.

"With the private label market for mortgages still non-functioning (Fannie and Freddie) offer the only liquidity and bid for mortgages in this market, other than bank and thrift balance sheets," Keefe, Bruyette & Woods analyst Frederick Cannon wrote in a note to clients.

And indeed, thrift and bank balance sheets aren't what they used to be, impaired as they are by their own losses on everything from structured finance to leveraged loans to housing related debt.

"The U.S. government ... in our opinion, will continue to stand by the GSEs in the current market to provide a level of support for home ownership and liquidity for housing," Canon said.

This is the crucial point. Banks are making fewer loans, and on tighter terms, while the securitisation market that formerly funded large loans, subprime loans and others is gone. Fannie and Freddie now fund 8 out of every 10 loans in the United States below the $417,000 level, according to regulatory data. By March, Fannie and Freddie accounted for 97.6 percent of the mortgage bond market, compared with less than 50 percent in the first quarter of 2007, according to UBS.