The Freddie and Fannie effect

If Freddie Mercury were alive, he would have cheered thousands in his audience in this time of economic gloom just as the Governmental take over of US mortgage giants Freddie and Fannie seems to be cheering the US dollar. The US Government’s move has not only cheered the dollar, the stronger dollar itself is helping ease oil prices and has also elicited cheer from the stock markets. A stronger dollar has also led gold prices to fall below $ 800 and ounce.

The above effects are a clear indicator of the perilous state of the US housing market and its effect on the global economy that a governmental seizure of Freddie Mac and Fannie May seem to have instilled a sense of confidence into the system. After all, Freddie and Fannie were responsible for nearly 80% of housing mortgages issued this year.

While the governmental takeover of Freddie and Fannie does not amount to nationalization as that could have only been done via an act of Congress, the two agencies are now virtually under government guarantee. This has been achieved via a four step process including a conservatorship, access to loan facility, propping up their net worth via purchase of preference shares and becoming a buyer of the last resort of bonds of the two agencies. Stabilization of Freddie and Fannie is expected to lower mortgage rates and revive the sagging US housing market. The guarantee on bonds has helped instill stability in the international markets as China and Japan are the biggest buyers of Freddie and Fannie bonds and now their investments are under virtual US government guarantee. As per US Treasury data, China is the biggest holder of US agency debt amounting to $376 billion followed by Japan at $229 billion as of mid 2007.

Suddenly, the currency speculator is seeing that the US Government has taken bold steps that can jump start the end of the US housing crisis by the lowering of interest rates. So the speculator seems to have gained back his respect for the US dollar and is betting harder on it. At the same time other economies like that of Europe and Japan are not performing well. While, the US economy seems to be making attempts at recovery, the other economies seem to be getting deeper into the economic muddle. Relatively, this imparts strength to the US dollar vis-à-vis other currencies and so we can see an upward trend in the US dollar.

The dollar’s display of muscles seems to be having some other positive effects as well. The Freddie and Fannie effect seems to have pushed oil prices down to around $105 a barrel. Lowered oil prices are likely to help cool off inflation as well, which is good news for the US economy and provides leverage to the Fed to cut interest rates. In parallel, gold dipped below $800 an ounce, which was indicative of the fact that the dollar is regaining its position as a safe store of value. Usually gold prices move upwards when its intrinsic value starts being preferred as a store of value in times of economic uncertainty.

Three cheers to the governmental move! But, can the government continue its largesse if other financial institutions were to crash….rumors of the collapse of Lehman Brothers are already sending ripples in financial markets around the world!!