The Bush administration ripped up years of laissez-faire economic policies last night and launched a government takeover of two of the most powerful mortgage companies in the US.
The move is designed to forestall a collapse in house prices that could plunge America into a new Great Depression and trigger chaos on the world's financial markets.
The seizure of the two lenders, Fannie Mae and Freddie Mac, puts a federal guarantee behind an extraordinary $5trn of outstanding mortgage debt, and writes a blank cheque from the US taxpayer that could ultimately run into tens of billions of dollars of support for the country's ailing housing market.
The US Treasury Secretary, Henry Paulson, said that by bringing the companies under government control, the government could ensure they continued to do their vital work providing financing to the mortgage market. Without them, few Americans would be able to find loans to buy homes, consumer confidence could collapse and the already fragile global economy would contract dramatically.
"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation."
In the US, Fannie and Freddie own or guarantee almost half of all outstanding mortgages. Their finances have been wrecked by the credit crisis and by rising mortgage defaults by American homeowners.
The backlog of properties for sale is at its worst since modern records began, as repossessions mount. Fannie and Freddie have had to absorb $14bn of losses in the past year and, with more to come, they needed a huge injection of capital just to survive.
A secret government review of Freddie Mac's finances found that it might be in an even more parlous state than was previously feared, prompting the US Treasury to act yesterday before the financial markets reopened. For months, investors have fretted about the risks posed by the tottering companies, even as executives said they expected to be able to raise cash from Wall Street and overseas.
It is now clear that the necessary funding will have to come from US taxpayers. An initial $1bn will be followed by extra money as needed, Mr Paulson said. The Treasury will also directly purchase mortgage-backed securities from Fannie and Freddie, starting with $5bn this month. In return, the companies have agreed to a "conservatorship" under the oversight of the Federal Housing Finance Agency. The government could end up owning 80 per cent of the two.
They will have to be slimmed down to about a third of their current size, Mr Paulson said yesterday, although that could prove politically controversial. The Democrats have long seen Fannie and Freddie as a useful means of encouraging home ownership by providing access to cheap mortgage finance.
Mr Paulson briefed the US presidential candidates, John McCain and Barack Obama, about his plans over the weekend. Mr Obama said he understood the situation was "extremely serious", adding: "Any action we take must be focused not on the whims of lobbyists and special interests worried about their bonuses and hourly fees, but on whether it will strengthen our economy and help struggling homeowners."
Mr McCain also supported the bail-out, saying: "There has got to be restructuring, there has got to be reorganisation and there has got to be some confidence that we have stopped this downward spiral."
In his first action as de facto boss of the two companies, Mr Paulson sacked their chief executives yesterday, installing the manager of a teachers' pension fund to run Fannie Mae and a banking executive to run Freddie Mac.
Fannie Mae was first created as a government agency to help pull the US out of the depression of the 1930s by creating a secondary market for mortgages. It was privatised in 1968, and Freddie Mac was created as a similar shareholder-owned company two years later.
Despite attempts by the Bush administration to shrink the two companies, they have become even more vital to the housing market since the credit crunch struck and Wall Street stopped providing alternative finance to the mortgage industry. Two in every three new mortgages agreed in the US are with Fannie Mae or Freddie Mac.
Even more significant in many Treasury officials' minds is the pivotal role they play in the modern world of inter-connectedfinancial markets. Almost $1trn of debt issued by the two companies is held overseas byforeign governments, and their failure could have triggered a flight of capital from the US.
Giants of the mortgage market
*Fannie and Freddie between them account for $5.3trn (£3trn), or around half of the US mortgage market
*In 2008, Fannie and Freddie issued more than 80 per cent of all new mortgages
*A homebuyer with a $150,000 mortgage can save $18,000 in interest, according to Freddie Mac marketing
*Fannie Mae, or the Federal National Mortgage Association (FNMA), was set up as a government agency in 1938 as part of Roosevelt's New Deal. It became a private corporation in 1968. Freddie Mac was born as the Federal Home Loan Mortgage Corporation (FHLMC) in 1970
*Freddie Mac has financed homes for more than 50million people since 1970
*More than 95 per cent of Freddie-financed apartment units, and more than half of Freddie house mortgages, are owned by low- to middle-income families
*Foreign governments hold almost $1trn in Fannie and Freddie bonds and 66 central banks have investments in Freddie securities
*In August Freddie Mac admitted that its debts outstripped its assets by $5.6bn
*Fannie Mae employs 6,400 people, Freddie Mac 5,000
*By July Fannie and Freddie had lost $12bn since the sub-prime crisis began a year before
*Housing and related industries represent a fifth of the US economy