�You�ve heard of mental depression. Well, this is a mental recession.� So said Phil Gramm, economic adviser to John McCain, in �desperation last week at the gloomy state of the markets.

You've heard of mental depression. Well, this is a mental recession." So said Phil Gramm, economic adviser to John McCain, in desperation last week at the gloomy state of the markets. You might be inclined to agree with him if you've been trying to follow the incoherent ravings over the weekend concerning the fate of Fannie Mae and Freddie Mac, who sound like a couple of old-time vaudeville acts but are actually giant US state-backed mortgage lenders.

The Federal National Mortgage Association, aka Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac, together hold half of all US mortgages, around $5.3 trillion worth of debt. Last week, after rumours that Fannie and Freddie were "technically insolvent", there was a desperate dash for the exits. Fannie's shares fell 50%, bringing most of the world's stock markets down with them. The Wall Street Journal reported that the government was planning to nationalise Fannie and Freddie, an option hastily ruled out by the US Treasury Secretary, Henry Paulson.

Yet since these are already state-guaranteed banks - Fannie was set up during the Depression - and cannot go bust, at least not in theory, you might wonder why they have to be rescued. Why has there been a blind panic over the weekend in the White House and at the Federal Reserve? Why were investors cutting their own throats by withdrawing their funds? Why have the shock waves hit Scotland's two biggest financial institutions? Royal Bank of Scotland shares fell sharply on Friday in Fannie's wake, and HBOS is now fighting a losing battle to raise more cash from its shareholders this week.

This really does look like time to call in the men in white coats - especially since the Fannie and Freddie show almost eclipsed news that another huge US bank, IndyMac, really did go bust last week, the second largest lending bank in US history to do so, leaving its depositors literally banging at the door. Financial panics are always a combination of psychology and cash, but this looks like a kind of financial nervous breakdown - a collapse of confidence in the entire US financial and political establishment.

You might be tempted to dismiss all this as just more sub-prime lunacy, of little relevance to the "real economy" in America or here. After all, most of us are still in secure jobs and sitting on a decade of capital gains in our houses. Let Wall Street get in a state - it's what it does. Unfortunately, we can't ignore what is happening because we are so closely tied to the US economy, and what happens over there is likely to happen here in about six to 12 months.

Fannie Mae and Freddie Mac are not an afterword to the sub-prime crime but a whole new dimension to it. They did not deal in dodgy loans to unemployed people who couldn't afford them but to the great mass of middle-class Americans who could (at least until recently). However, the 20% collapse of house prices in the States - now happening here - has hit the Big Macs harder than anyone expected. Now they cannot meet their liabilities - and, if left to the market, would cease to be.

Everyone agrees that Fannie and Freddie simply cannot be allowed to go bust. It would be like a financial hydrogen bomb, the fallout from which could cause a global depression. The practical option might seem to be to bolster confidence by actually making explicit what is implicit in Fannie and Freddie's constitution and take them formally into national ownership - a bit like Northern Rock, but on an epic scale.

However, not only is nationalisation inimical to the American way of capitalism; swallowing these massive mortgage banks whole would also have a profound effect on the finances of the US. Their loan book would almost double the size of the US public debt. Yet many commentators say the US government cannot simply hand untold billions to ailing privatised banks, however important they are, because this would be unfair competition and an illegitimate use of public funds.

Now, all this matters to us because, like a time machine, it shows us what impact the UK house price collapse is likely to have on this side of the Atlantic, and what the government may eventually have to do to respond to it. We don't know who our Fannies and Freddies are yet, though the worrying thing is that British banks such as Northern Rock and Bradford and Bingley have been struggling already, and our house price slide has barely started. The UK house price bubble inflated even higher than in America so has much further to fall.

Such mainstream analysts as Merrill Lynch are talking of a 30% drop in UK house prices. (And don't delude yourself that Scotland might be immune to this slump: the unprecedented decline in bank lending behind it is happening north and south of the border.) The mortgage lenders have already factored in a steep fall, which is why they won't lend to people unless they can come up with a whacking deposit. Now, you may remember that the mortgage famine was supposed to have ended in April after the Bank of England introduced its £70bn Special Liquidity Scheme to help the banks. The Chancellor, Alistair Darling, was confident that this would lead to a reduction in mortgage rates. It didn't, and last week the mortgage lenders went again to Threadneedle Street to call for yet more loans as their balance sheets continue to go south. The banks are becoming more dependent on public funds for their survival.

What we are seeing is something quite extraordinary: the creeping nationalisation of the US and British banking system. Most of Wall Street is on life support from the US Federal Reserve and we're going the same way. If Freddie and Fannie are nationalised, America would start to look a bit like China, where the state controls the banking system through ownership of the biggest financial institutions. There is a rich irony in the Republican Party, defender of conservative economics, presiding over the socialisation of the US economy.

The UK Treasury, as it contemplates handing almost unlimited funds to banks, might well consider the implications of this. It may be that a fully private banking system is no longer possible, and that the state is going to have to take a strategic stake in the financial sector as a matter of policy rather than as a temporary expedient.

That may seem an incredible proposition, but the alternative of throwing ever more taxpayers' money at failing banks is equally unacceptable, morally and financially. As the financial world takes leave of its senses, who else is going to manage the asylum?