In a rather disturbing way, Fannie Mae and Freddie Mac are not too different from the Australian banks.

They operate with an implied government guarantee — not an actual guarantee, of course, but the presumption that they are too big and too important to be allowed to fail.

They take on liabilities cheaply because of that and then make a very good living lending that money on residential mortgages that are still cheaper than if ordinary borrowers had to go to the wholesale market themselves. Everyone wins.

Fannie and Freddie are now in trouble because they hold mortgage securities that have to be “marked to market” according to accounting standards, and the market for those things has collapsed.

All of a sudden their tiny regulatory capital ($US86 billion supporting $US5 trillion of mortgages) is nowhere near enough.

But imagine what would happen if Australian banks had to value their mortgages at market value.

There is an Australian secondary market in mortgages and it, too, has collapsed, but thank goodness the banks and their auditors can ignore that and continue to value their residential loan assets at cost.

And even better for the Australian banks, all of the originators and securitisers that don’t have even the slightest hint of a government guarantee, and have been causing the banks so much competitive grief for the past decade, have fallen away like so much rabble, leaving the banks to get back to making juicy profits on the back of their implied government guarantee, but now with no competition.

It is truly a beautiful thing for the banks, but no-one in Australia should laugh at the mess that the Americans have gotten into with Fannie and Freddie: there but for the grace of accounting standards go us.

The only reason the Australian banks didn’t take on a whole lot of securitised assets that would now have to be written down, destroying shareholders’ equity, is that they didn’t have to: their balance sheets are supported by the Australian habit of handing over cheap retail deposits because they’re safe.

And now that the wholesale markets have dried up, removing an important source of funding for the banks, the government has quietly stepped in via both the Reserve Bank and the Future Fund to make up what the banks aren’t able to get from depositors, as detailed yesterday by Tony Boyd in Business Spectator.

So when the London School of Economics’ Willem Buiter, writing in the Financial Times, calls the situation with Fannie Mae and Freddie Mac “hypocritical”, “deceitful”, “dishonest” and “spineless”, and says the US government must nationalise them… well, yes, but don’t look too closely at your banks, Willem.

Fannie Mae was created in 1938 as part of Franklin Delanor Roosevelt’s New Deal and held a monopoly of mortgage securitisation for 30 years, until it was privatised in 1968. Freddie Mac was created in 1970, also as a privately-owned company to provide some competition (although what it actually provided was a cosy duopoly).

The Commonwealth Bank of Australia was created in 1911 to conduct saving and lending with an explicit government guarantee. Around the time Fannie Mae was created in 1938, its functions were expanded to include central banking and it took over the state savings banks of WA and NSW, but it continued to use the government guarantee to provide housing loans.

Its privatisation began in 1991 and finished in 1997, but it continued to raise deposits on the same terms and still forms the foundation of the Australian mortgage market — just as Fannie Mae does still.

But the Federal National Mortgage Association, as Fannie Mae is really called, is a wholesaler not a retailer, and it holds mortgage securities, not actual loans.

Those securities have to be valued at market; Commonwealth Bank’s assets do not. Phew.

Meanwhile, back at panic-stations — Freddie Mac’s $US3 billion sale of short-term notes went off well last night, but its shares, and those of Fannie Mae, were trashed anyway. They opened higher, but then their inherently unsustainable situation reasserted itself.

Yesterday Treasury secretary Hank Paulson issued a press release announcing a new three-point plan, presumably hoping the press release would do the trick.

It had the intended effect of restoring some confidence to begin with, until investors realised that if the US Treasury actually did buy equity in Fannie Mae and Freddie Mac, then those “terms and conditions” would mean current shareholders would be wiped out.

On a mark-to-market basis, both institutions are probably insolvent and unless there is a rapid recovery in debt values, must be recapitalised. Only the government can do that, so it will probably have to.

Australians are more indebted than Americans and Australian houses are higher priced and less affordable than those in the US. If anything, the Australian economy is more vulnerable to a housing/mortgage market crisis than the US.

So with the Pope in town, let’s all thank God for accounting standards.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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