Federal Housing Finance Agency Director James Lockhart (left), speaks during a news conference with Treasury Secretary Henry Paulson Jr, in Washington, Sunday, September 7, on the bail out of mortgage giants Fannie Mae and Freddie Mac. - AP

The government has just become one of the biggest players in the United States mortgage market.

The Bush administration announced Sunday it was seizing troubled mortgage giants Fannie Mae and Freddie Mac in a bid to help reverse a prolonged housing and credit crisis.

But private analysts worried that it may not be enough to stabilise the slumping housing market given the glut of vacant homes for sale, rising foreclosures, rising unemployment and weak consumer confidence.

Mark Zandi, chief economist at Moody's Economy.com predicted that 30-year mortgage rates, currently averaging 6.35 per cent nationwide, could dip to close to 5.5 per cent.

That's because investors will be more willing to buy the debt issued by Fannie and Freddie - and at lower rates - since the federal government is now explicitly standing behind that debt.

"Effectively, the federal government has now become the nation's mortgage lender," he said. "This takes a major financial threat off the table."

Cost to taxpayers

Officials announced that both Fannie Mae and Freddie Mac were being placed in a government conservatorship, a move that could end up costing taxpayers billions of dollars.

United States Treasury Secretary Henry Paulson refused to estimate how much the takeover of the two companies will cost the government, but he insisted that taxpayers will get paid back first.

"We structured this facility to protect the taxpayer," Paulson said Monday in an interview on the CBS Early Show. "The government will be repaid ... before the shareholders of these companies get a penny."

In a separate appearance on CNBC, Paulson said "we obviously don't know" when asked how much the takeover could end up costing taxpayers. He said that will depend on how quickly the housing market turns around.

Wall Street posted a huge rally Monday as investors reacted with enthusiasm to the government's actions. The Dow Jones industrial average was up nearly 250 points in late morning trading.

Foreign investors own about US$1.5 trillion of the debt issued by Fannie, Freddie and smaller agencies such as Ginnie Mae with about US$1 trillion of that amount held by foreign governments.

Fannie and Freddie, which together own or guarantee about US$5 trillion in home loans, about half the nation's total, have lost US$14 billion in the last year and are likely to pile up billions more in losses until the housing market begins to recover.

The Treasury Department said it was prepared to put up as much as US$100 billion over time in each of the companies, if needed, to keep them from going broke, in exchange for senior preferred stock.

Treasury will immediately be issued US$1 billion of such stock from each company, which will pay 10 per cent interest.

Further purchases of preferred stock will be triggered if quarterly audits find that the companies' capital cushion is below prudent standards.

The government, which will receive warrants representing ownership stakes of 79.9 per cent in each company, is hoping that its moves will reassure nervous investors that they can continue to buy the debt of the two companies.

The conservatorship will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie, a move taken at the same time that Congress greatly expanded the power of the Treasury Department to make loans to the two companies and purchase their stock.

The executives and board of directors of both institutions are being replaced. Herbert Allison, the former head of the TIAA-CREF retirement investment fund, was selected to head Fannie Mae, and David Moffett, a former vice-chairman of US Bancorp, was picked to head Freddie Mac.

Placing the blame

Paulson was careful not to blame Daniel Mudd, the outgoing CEO of Fannie Mae, or Freddie Mac's departing CEO, Richard Syron, for the companies' current problems.

While both men are being removed as the top executives, they have been asked to remain for an unspecified period to help with the transition.

Fannie and Freddie both purchase home loans from banks and then repackage those loans as mortgage-backed securities that they either hold on their own books or sell to investors around the globe.

This process provides banks with more money to make more home loans, greatly expanding home ownership.

The impact of the government takeover on existing common and preferred shares, which have slumped in value in the last year, will depend on how investors react to Paulson's assertion that they must absorb the cost of further losses first.

Under the plan, dividends on both common and preferred stock would be eliminated, saving about US$2 billion a year.

- AP