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.

For those who don’t know, Fannie Mae and Freddie Mac are chartered finanicial institutions that guarantee 60 percent of the U.S. home loan market. Both are in serious trouble because of the meltdown in the housing market.

The U.S. Federal Reserve Bank

They dominate the top-tier of lenders that control $6 trillion of mortgage lending. A collapse would trigger an unprecedented crisis across the world’s largest economy and swift knock-on effects around the globe.

The Fed is pulling every lever 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 hopes to take the sting out of the troubled banking crisis.

Like the British mortgage bank, Northern Rock, Freddie and Fannie may have to be nationalized to shore up the economy.

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.”

A new book by Nobel prizewinning economist Joseph Stiglitz tracks the effect that the war in Iraq has had on the American economy. The Three Trillion Dollar War — The True Cost Of The Iraq Conflict outlines the immense downside across the globe of this policy.

In terms of the current credit crunch, which arose out the sub-prime mortgage fiasco, many had blamed Alan Greenspan, then Chairman of the U.S. Federal Reserve Bank, for keeping rates too low for too long. Combined with steeply rising house prices this gave the banks a one-way bet for lending to the trailer-park poor.

However, it’s clear from Stiglitz’s book that the low rate regime was engineered to mask the terrifying cost to the American economy of the wars in the Middle East.

We can now see the extent of the disaster to American interests the war is continuing to cause. The conflicts have led to a strengthening of Gulf, Chinese and other sovereign wealth funds which have bought up large chunks of prime U.S. assets, including blue-chip bank stock, while, in some cases, simultaneously enjoying a bonanza from higher and higher oil prices.

In ten years these bank stocks should prove exceptionally rich investments as they recover from current adverse credit conditions. The war has given them a one-way bet.

Joseph Stiglitz works out the numbers and they make depressing reading.

The American economy is now in recession. A slew of new data clearly reveals both a marked slowdown in activity, combined with a rise in inflation — something not seen since the stubborn “stagflation” period of the 1970s.

Despite all this, some economists expect a robust return to growth later in the year off the back of aggressive rate cuts by the Fed and a financial package from the President that will see checks delivered to taxpayers, and others on low incomes, by June.

We shall see.

Legendary investor, Warren Buffett — the Sage of Omaha — in a move he says is designed to make money, has offered to take on $800 billion of the liabilities of U.S. municipal bonds.

The offer goes to three “monoline” bond insurers, Ambac Financial, MBIA and Financial Guaranty Insurance. One has already rejected the deal, and he is still awaiting reponses from the other two, although one of them is making favourable noises.

The move breathed new life into global stock markets yesterday. The monolines are seen as the second line of defence against the sub-prime mortgage fiasco by propping up banks’ balance sheets in the event of a repayment meltdown.

Traditionally, the bond insurers concentrate on municipal risk, but they too got caught up in the collective madness of sub-prime lending for the same reason respectable banks did : greed for perceived easy money.

However, the monolines are now short of capital and are being hit by downgrades from the rating agencies.

T J Marta, fixed income strategist at RBC Capital Markets, said it was a coup for bond insurers, which could help them avoid “the doomsday scenario”.