If you think it's bad now, just wait... Ruth Sunderland The Observer, Sunday July 13, 2008 Be afraid - be very afraid. The UK government's problems with Northern Rock are dwarfed by those faced by the White House, which is faced with propping up Fannie Mae and Freddie Mac. Fannie and Freddie guarantee or own around $5.2 trillion (£2.6 trillion) of debt and have been bolstering the US mortgage market since the sub-prime crisis began. They have lost $11bn in the past few months and their shares have plunged on fears of much worse (see chart, below left). Freddie, according to a former head of the St Louis Federal Reserve Bank, is already technically insolvent. What happens to Fannie and Freddie is hugely important not just for US homeowners, but for the American economy, and by extension all of us. Foreign governments and central banks are big holders of their securities, and the Chinese and other emerging nations are the largest lenders to the American government, through their huge piles of Treasury bonds. The pair are too big to be allowed to fail - if they are unable to operate, the US mortgage market would come to a complete halt. The sheer scale of their liabilities has raised concerns about the creditworthiness of the US itself; Treasury debt was heavily sold on Friday, though ratings agencies said there was no immediate prospect of a downgrade to its triple-A sovereign rating. On both sides of the Atlantic, the credit crunch is entering an even darker phase. The bailouts of Bear Stearns in the US and Northern Rock here were not enough to stave off the demons and restore confidence; these rescues, in hindsight, only marked the end of the beginning. Here, we are in a toxic loop where the seizing-up of the financial system has led to a plunge in house prices and a construction slump; this will feed back into more bad debts and more strain on the banks. Lenders need additional capital, but the sovereign fund investors who provided the first tranche are sitting on losses, and the underwriters look certain to take a haircut in the cash calls by Bradford & Bingley and HBOS. As GFC Economics points out, the banks are on the brink, and Northern Rock might not be the only one that ends up being nationalised. Runs on branches are rare: a much more common cause of default is the unwillingness of investors to stump up fresh capital. As for the housing market, which we have foolishly relied on as an economic crutch, Merrill Lynch suggests it may slump by nearly 30 per cent over the next three years and, as its chart (below right) demonstrates, property prices may show very little recovery in real terms for 20 years. Yes, 20 years. In a little remarked statement, the Bank for International Settlements pointed out that there are also $500bn of private equity loans coming up for refinancing by 2010, and given the booming business the sector enjoyed in the UK until recently, that does not bode well. So much for those who thought the crunch would be shortlived. What, if anything, can we do as individuals? Assuming you're not an oil sheikh, the best plan if you can do it - and I'm aware it's a big if - is to pay down debt and build up cash as a cushion, or as a war chest for when markets stabilise and bargains begin to emerge in shares and property, though it would take bravery to act now. Oh, and do try to keep your job. How bad will it get? I hate to think, but it's time for the tin hats.