Political pressure is building in the US for a government-supported bail-out of low-income homeowners, whose rising mortgage arrears have sparked a full-blown global financial crisis.
The chairman of the powerful Senate banking committee, Democrat presidential candidate Chris Dodd, pressed his case yesterday for allowing Freddie Mac and Fannie Mae, the government-backed mortgage companies, to offer new sub-prime loans for low-income homeowners who have got into trouble.
Mr Dodd used a meeting yesterday with Ben Bernanke, the chairman of the Federal Reserve, and Hank Paulson, the Treasury Secretary, to pile pressure on the pair to do more to alleviate the financial difficulties for millions of homeowners who have taken out onerous mortgages in the past three years. He also said he believed an interest rate reduction by the Fed would help to ensure that the crisis does not dampen economic growth.
Before the meeting, new figures showed the number of foreclosures in the US had almost doubled in a year. Lenders sent 179,599 notices of default, scheduled auctions or bank repossessions last month, a 93 per cent increase from a year earlier, according to the consultants RealtyTrac. Just five states - California, Florida, Michigan, Ohio and Georgia - accounted for more than half of the country's total filings.
Freddie Mac and Fannie Mae are publicly quoted companies which buy and sell mortgages issued by other lenders. They operate with a federal government guarantee and under strict controls, with the aim of ensuring there is funding available to mortgage lenders and home ownership is encouraged. They have not, however, been allowed to support the so-called sub-prime, or "non-conforming", loans handed to low-income borrowers in recent years, which have been funded by much more complicated debt instruments invented by and traded on Wall Street. These instruments have fallen suddenly out of favour as a result of rising defaults, creating a funding crisis for mortgage lenders and jacking up mortgage rates for all new borrowers.
Senator Dodd said the role of Fannie and Freddie should be dramatically expanded and he blamed the Federal Reserve for failing to fault dubious lending practices. He estimated that between 1 and 3 million people are at risk of losing their homes, " not because they lost their jobs, not because the economy collapsed, but because they got bad deals on mortgages".
The Bush administration has resisted the proposals for fear of endorsing poor lending practices by the mortgage industry. Mr Paulson said the financial crisis would take time to resolve, but that current "stresses and strains" came against the backdrop of a fundamentally sound economy. "These issues have not been precipitated by weak economic conditions, they've been precipitated by excesses and by bad lending practices," he said.
At the meeting, Mr Bernanke promised to use all the tools at his disposal to restore activity in the debt markets, and said he would act later this week to encourage more banks to borrow directly from the Fed at its " discount window". This is where the Fed lends to the banking system, taking in currently unloved debt instruments as collateral. The Fed cut its discount interest rate last week, and yesterday its New York overshoot cut lending fees to encourage more banks to use it as a lender of last resort. The Fed also pumped an extra $3.75bn into the financial system through overnight lending.