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Fannie, Freddie, Cheshire and Derbyshire

• Robert Peston
• 7 Sep 08, 02:54 PM

After a brief period of calm in the summer, new disturbing evidence has been disclosed today of the weakened condition of financial institutions, both big ones and smaller ones.

The US Government is in effect nationalising North America's two biggest providers of finance for the housing market, Fannie Mae and Freddie Mac.

Their regulator, the Federal Housing Finance Agency, is taking direct control of them under a system known as "conservatorship".

This is an event of profound significance for the global economy, since these two eccentric institutions own or guarantee almost 拢3000bn of US mortgages.

Banks, including some of the world's most important central banks, have direct and substantial financial exposure to both Fannie and Freddie.

So, given the febrile state of markets across the world, it has become dangerous for doubts to persist about whether these two are viable and would be able to keep up the payments on their massive liabilities.

What's brought Fannie and Freddie to this humiliating impasse?

Well there's the continued decline in the US housing market, the sorriest housing market on the globe (for all the falls in UK house prices).

And then there's the discovery by Morgan Stanley, the investment bank advising the US government, that Freddie's capital resources are smaller than meets the eye.

For the US Treasury, the bailout could turn out to be one of the most expensive financial rescues in history, running to tens of billions of dollars.

Bad news, except perhaps for our own Chancellor of the Exchequer, Alistair Darling - since the Fannie and Freddie rescue costs may well make the potential losses for the taxpayer from Northern Rock seem almost modest (well almost).

Also the US banking debacle gives a bit more credibility to Darling's claims that the UK's economic and financial woes are at least in part the consequence of a global storm, for which he shouldn't be blamed too much.

In fact, while I write, two of our own housing-finance institutions are being steered by the Financial Services Authority into safe harbour, as the Nationwide negotiates to take ownership of two rival building societies, the Cheshire and the Derbyshire.

These are tiny compared with Fannie and Freddie, but they are not trivial in a UK context.

Derbyshire is the UK's ninth largest building society with 拢7bn of assets and the Cheshire is number 11 with 拢5bn. Together they have not far off a million customers.

But each has a structural flaw which makes it harder for them to carry on as an independent.

Derbyshire is perhaps a bit too dependent on funding from wholesale financial markets, which since the onset of the credit crunch last summer has been much harder to obtain.

And Cheshire has a commercial property business that is not in the greatest shape.

So although neither of them are bust and there is no reason for their depositors to be unduly alarmed (their savings are safe), the City watchdog, the FSA, wants them under the stewardship of the more robust Nationwide.

The harsh reality of the decline in the housing market means that the members of the Derbyshire and the Cheshire should not expect a windfall or any kind of payment from this deal.

Nor will they get a vote on whether the mergers will go through, as normally happens in consensual deals.

I have learned that the FSA will use its power to force through the transfer of ownership fairly speedily - because any period of uncertainty about the ownership of a bank or building society right now is fraught with risks.

UPDATE 17:31

The scale of the support being provided by the US Government to Fannie Mae and Freddie Mac is quite breathtaking - up to 拢110bn and the right to own 80 per cent of each of them.

This may not be conventional nationalisation, but its effect is the same.

The two mortgage providers will be under the direct control of their regulator, they will be run by two new chief executives selected by that regulator (both of whom have reasonable track records), and it will be US taxpayers who will have the formal ability to take majority control of them.

What's been announced makes the nationalisation of Northern Rock in the UK look like small beer.

Why the dramatic evasive action?

Well these two provide a good half of all mortgage finance in the US - so when they're in critical condition, there's no possibility of recovery in the ailing US housing market.

And if the US housing market doesn't recover, that prevents the US economy from recovering - and as the boss of HBOS told me (see yesterday's blog), it also prevents the UK economy from getting back on track.

What's more their health is vital to confidence in the global financial system, since more or less every commercial and central bank on the planet has some kind of exposure to them.

So not only are they too big to fail, but they've also got to be returned to some kind of viability for all of us to start to feeling a bit more prosperous again.

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