Mac Mae be the biggest bailout

Putting Freddie and Fannie under government control amounts to default, meaning those contracts may have to be settled, although since dealers never disclose CDS positions, it may take some time to emerge.

Paulson was hoping his actions would underpin the housing market and bring down mortgage rates.

Capital Economics estimates the move will cut the yield on mortgage interest rates by one percentage point taking a 30-year rate from 6.4% to a four-year low of 5.4%.

However, that may not be enough to put a floor under the US housing market, given the excess of supply, the rate of repossessions and the rise in unemployment.

It seems the rescue of Fannie and Freddie was a necessary, but not sufficient condition for recovery.

As Capital Economics’ Paul Ashworth says: “If the Treasury had allowed them to fail, the only significant source of funding in the mortgage market would have disappeared.”

This begs the question as to whether the UK should follow suit. So far, news of the US slashing rates and bailing out failing institutions has met with stony faces in European capitals.

One reason is that the US is guided by a fear of a return to the Great Depression, while Europeans fear hyperinflation.

Different strokes
There are more practical reasons why the UK may not follow the US’s example despite growing political pressure. The Treasury is probably right in saying that we have a different mortgage market from the US.

The UK does not have equivalent organisations to Freddie and Fannie. The collapse of Northern Rock shows that certain mortgage lenders may have an implicit guarantee.

While mortgage finance has dried up in the UK, the problem is a spike in mortgage rates combined with still-high house prices.

As the interim report into mortgage finance by FSA deputy chairman Sir James Crosby showed in July the e280bn of outstanding residential mortgage-backed securities in the UK compares with e4.69 trillion in the US, of which 82% was backed by agencies such as Freddie and Fannie.

Mervyn King, Governor of the Bank of England, has firmly set his face against any further taxpayer guarantee for mortgage funding.

He told MPs in September that a new permanent facility to replace the Special Liquidity Scheme ­ which allowed banks to swap illiquid mortgage-based assets for Treasury Bills as collateral to raise cash ­ would not be as large. He said the new scheme, which supersedes the old one in late October, “would not and cannot solve the shortage of funding to finance bank lending, including mortgage lending”.

UK house prices, as in the US, will continue to fall, mainly because only that way will they find a natural floor. As King said at his August inflation briefing, neither the government nor the bank can set that new level.