Fannie and Freddie won't fail, but will they lend?

By James Saft - Column

LONDON (Reuters) - We now know Fannie Mae and Freddie Mac won't be allowed to fail, but the question for the banking system and economy becomes: will they be able to lend?

The United States took extraordinary steps on Sunday to ward off a crisis of confidence in the two government sponsored enterprises (GSEs), moving to increase a Treasury department line of credit and make a provision to buy equity in the companies if needed. Both steps require Congressional approval.

The Federal Reserve separately moved to open up a borrowing window to the mortgage giants.

This wards off the disaster that would have happened if either of the two were unable to fund themselves, and by establishing a solid gold backstop makes it hugely less likely that they will have trouble borrowing in the debt markets.

What is a lot less clear is how and to what extent Fannie and Freddie will be able and willing to lend into a U.S. real estate market that is both still falling rapidly and desperately in need of finance to stave off even worse falls. To do that will require new capital, a lot of it.

Treasury Secretary Hank Paulson stressed government support for the GSEs as shareholder-owned companies. But how to put a big wedge of public money into Fannie and Freddie without savaging existing shareholders and choking off the hope of new capital raisings?

If the government made an equity investment on the basis it would absorb initial losses in order to tempt new capital into Fannie and Freddie, they'd in effect be socialising the losses while keeping the gains private.

And remember, to stave off accelerated falls in U.S. housing, Fannie and Freddie need to not just guarantee and sell mortgage securities to investors but continue to grow their own retained portfolios of loans.