Yesterday the U.S. Treasury Secretary, Henry Paulson, nationalized the underwriters of half of America’s vast mortgage industry, now in precipitate decline.

Secretary Henry Paulson at news conference yesterday

Two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, have had their books underwritten in the short term by the Government.

Fannie and Freddie are curious institutions. They don’t lend money but underwrite half of U.S. mortgage lending. This amounts to a staggering $5.2 trillion (£2,940 billion) of debt. The two companies are a kind of buffer zone between mortgagees and the real world of finance.

Since the Great Depression, the Government has tacitly made it known that it will support Fannie and Freddie through any adversity. Now that wink has become explicit — until the end of 2009.

So the managers of these enterprises are out, and the shareholders are sent to the dogs, losing 79.9 percent of their holdings to the Treasury. The bondholders — most central banks and commercial banks around the world — are safe, by Government decree. The alternative would have been a liquidation of dollar holdings on an unimaginable scale.

Predictably, bank shares have risen sharply around the world, while the dollar has lost some of its recent glitter in the markets, reflecting the new self-imposed straitjacket binding the Government’s hands for the foreseeable future.

Henry Paulson explained the thinking behind the move. “Fannie Mae and Freddie Mac securities are held by central banks and investors around the world. Investors have purchased securities of these enterprises in part because the ambiguities in their congressional charters created a perception of government backing. Because the U.S. Government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and mortgage-backed securities.”

He has also committed the Treasury to pumping up to $100 billion into each of the GSEs in the event that their capital ratios fall short.

Fannie and Freddie will now be able “moderately” to increase their lending.

This article is adapted from a piece which appeared in Syntagma on March 12.

The rest of the world may not know who, or what, Fannie Mae and Freddie Mac are, but Americans do. They are the financial institutions that guarantee 60 percent of the U.S. home loan market. Both are on the edge of meltdown.

The U.S. Federal Reserve Bank

They are also the leading players in a top-tier of lenders that control $11 trillion of mortgage lending. A collapse would trigger a catastrophe of unprecedented proportions across the world’s largest economy with swift knock-on effects around the globe.

What is emerging now is the greatest financial crisis since the Great Depression in the 1930s. If America’s huge mortage banks are no longer rock solid, nothing is safe anymore.

The Fed is pulling every string available to it to neutralize the toxic effects of the subprime disaster. It’s predicted to lower rates by another 75 basis points within days, and is now offering Treasury bonds in exchange for mortgage debt. By soaking up some of the poison, the central bank is temporarily providing a shoulder to lean on for jumpy bankers whose world is disintegrating around them.

Like the British mortgage bank, Northern Rock, Freddie and Fannie may have to be nationalized — or their dubious collateral underwritten by government agencies — to shore up the economy against plunging over the edge. And Bear Stearns is in serious trouble too.

All this makes the UK Chancellor of the Exchequer’s budget today rather small beer. And that’s just what we expect — taxes on beer and faux “green” measures to raise a little cash here and there.

The real action is in Washingtom, where the Fed is leading the charge against a U.S.-generated global meltdown of potentially epic proportions.

Bernard Connolly, Global Strategist at Banque AIG, believes Fed action won’t solve the problem of eroded of bank capital. “There is the risk of a very damaging credit contraction. We face the most serious global crisis since the Great Depression. But this time at least the North American central banks are doing their best to stop it spreading to the real economy. We should be thankful that we have people in charge who appreciate the gravity of the situation.”

True enough, but the “perfect storm” is gathering perfection by the hour.