ANALYSIS:THE RESCUE of Fannie Mae and Freddie Mac amounts to more than a stabilisation plan - it is a bold policy intervention that aims to brighten the outlook for housing, credit and the US economy.
As such it could have a significant effect on the course of the credit crisis, although it will probably not be enough by itself to deliver a turnaround.
The US government is taking control of three-quarters of the US mortgage industry as measured by the flow of new home loans. Moreover, it is now committing public money to buy mortgages.
This is a dramatic change, and one that gives the US authorities the chance to get ahead of the curve in a policy sense, after months in which even pre-emptive interest rate cuts and a fiscal stimulus left them behind fast-moving events.
In principle, the US government could use Fannie and Freddie as a Federal Reserve for housing - using fiscal support to drive down mortgage rates, independent of interest rates. This offers a potential solution to a problem that has dogged the US economy since the start of the credit crisis: soaring risk spreads in home loans meant that mortgage rates are higher today than they were a year ago in spite of 325 basis points of Fed rate cuts.
First, the government hopes that risk spreads on Fannie and Freddie debt - a key input into mortgage costs - will now collapse.
Second, it will look to cut the fees Fannie and Freddie charge on the loans they guarantee and might also direct the companies to ease underwriting standards.
Lower mortgage rates should help the housing market to stabilise sooner, and trigger a refinancing boom, putting cash in consumers hands and supercharging the previous Fed rate cuts.
But the Treasury's ability to drive down mortgage rates will be constrained by its need not to push up its own borrowing rates by taking on too much debt and mortgage risk.
At the same time, the intervention aims to shore up confidence among foreign investors in US dollar assets. Throughout the credit crisis, policy-makers have worried about the risk that a flight from US assets would greatly aggravate the credit crunch, forcing a brutal adjustment in US savings and investment.
As Treasury secretary of a debtor nation, Hank Paulson was determined to keep the faith with foreign investors, honouring the assumptions on which they invested.
Analysts are now grappling with how much of an impact the plan will have on housing, and to what extent this will help to turn round the market and economic outlook.
High mortgage rates are not the primary reason why house prices are falling. Stocks of unsold homes remain high, prices are still elevated on many fundamental measures, the risk of local foreclosure spirals remains high, and rising unemployment now poses a fresh risk to house prices.
So lower mortgage rates will help, but not transform the baseline case for house prices.
Still, reducing the risk of an extreme collapse in house prices helps a wide range of housing-related assets and bank stocks which soared yesterday.
But will it turn things around? To a large extent this depends on the extent to which the current crisis is essentially a housing problem, as opposed to a broader credit problem.
Mr Paulson said housing was "at the heart of the turmoil and stress for our financial markets and financial institutions".
Yet other policy-makers see the current crisis as being more about a massive adjustment in the financial system.
David Rosenberg, chief US economist at Merrill Lynch, said Fannie and Freddie were "really symptomatic of a much larger problem . . . it is the larger problem of excess leverage".
The US government may end up having to support the recapitalisation of a much wider range of financial institutions in order to curb the credit crunch. - ( Financial Times service)
