Commentary: Nightmare on Wall Street: Asian capital flight
William Pesek Jr. Bloomberg News
Monday, June 16, 2003
TOKYO It is often said that the United States has built a large, productive economy over the years - and that Asia holds the mortgage. The world's largest economy has become addicted to the hundreds of billions of dollars worth of Asian capital sent its way each year.
It finances a fast-widening current account deficit, allowing the United States to live beyond its means. It keeps bond yields low, stocks up and spirits high.
Not surprisingly, the mere thought of Asians stampeding out of dollar-denominated assets keeps some Washington policymakers and New York investors awake at night. Last week, that nightmare edged closer to reality for Freddie Mac. Asian investors, spooked by an investigation into accounting at the second-largest U.S. buyer of mortgages, dumped Freddie Mac securities.
Hisanori Takayama, a fund manager at Taiyo Life Insurance in Tokyo, is exactly the kind of investor that a U.S. government-sponsored enterprise, or agency-debt issuer, needs to worry about. Like many in Asia, he bought Freddie Mac bonds because of their AAA debt rating and liquid secondary market.
And now?
"I'd like to reduce my holdings of Freddie Mac bonds," Takayama says.
The trust of many investors in Asia was shaken by the news that Freddie Mac had dismissed its top three executives amid a restatement of financial results. It seemed all too reminiscent of the Wall Street accounting scandals of recent years.
Once again, troubling questions have been raised about whether the United States is reforming its system of corporate governance or merely papering over the cracks.
Freddie Mac now has a huge credibility problem in Asia, a region that has been a steady buyer of its debt.
In the first three months of 2003, Asians bought over $32 billion of U.S. agency debt, while Europeans bought less than $20 billion, according to U.S. government figures. While data change rapidly, many analysts and traders figure Asians hold roughly a third of all U.S. agency debt at any given time. And most of that is held by the region's central banks.
The good news is that central banks do not seem to be selling their stockpiles of Freddie Mac or other agency debt - yet. Monetary authorities do not disclose timely data on their holdings, but the orderliness of last week's Freddie Mac sell-off suggests the biggest Asian debt holders are not panicking.
Last week, the yield premium, or spread, on 10-year Freddie Mac bonds widened from 26 basis points, or 0.26 percentage point, relative to comparable U.S. Treasuries to 40 basis points. The spread on five-year notes widened by 8 basis points to 23.5 basis points.
If Asia's central bankers were dumping Freddie Mac, the spreads probably would have widened by much more.
Yet the agency has serious hand-holding to do in Asia to restore the market's trust. As the U.S. Securities and Exchange Commission's investigation unfolds, investors will be watching for signs of deeper trouble at Freddie Mac.
Investors also want to know if Congress will move to sever the line of credit that U.S. agencies enjoy with the government. That implicit guarantee is the main reason Asian central banks buy bonds issued by Freddie Mac and other entities like Fannie Mae, another mortgage-buying agency.
Higher yields relative to U.S. Treasuries also appeal, but the belief - misguided or not - that the federal government would save Freddie Mac-like agencies from bankruptcy is the key attraction.
Freddie Mac's woes get at a broader risk for the U.S. bond market: Asians dumping their vast holdings of dollar-denominated debt. That possibility, as remote as it seems, has been a recurring fear for years in Washington and New York.
Will Freddie Mac prove to be a microcosm of the U.S. economy?
While many investors downplay the risk, the United States has never been more reliant on foreign capital to fund its way of life. For decades, it has benefited from Asia's household savings, which flow disproportionately into dollar assets.
That allows the United States to fund trade gaps and finance mergers and acquisitions. The capital also helps markets rally and traders make loads of money.
But the good times may be ending. For one thing, confidence in the U.S. economy isn't high in Asia. Wall Street economists seem to miss that point when they predict the Federal Reserve's rate cuts and lower taxes will save the day. It will not be that simple if the United States stops getting regular capital injections from Asia.
More and more, Asians buzz about putting money in the euro as a means of diversifying away from the dollar - especially now that the euro has stopped falling. Throughout Asia, there is also a move afoot to create a regional bond market. The idea is to keep in Asia more of the savings the region tends to wire to the West.
Another risk is a rebound in Japan's stock market. While there are more factors working against Japan's economy than for it these days, many analysts are wondering if now is the time to buy yen assets. Japanese stocks rose last week in the busiest trading since 1989.
That is the same year, incidentally, that the Nikkei 225 stock average peaked before the country's equity bubble burst.
Given the fragile state of the U.S. recovery, it would not be surprising to see more Japanese investors opting to keep their money at home. That could take a major leg of support out from under U.S. bonds, not to mention the economy.
Former President Ronald Reagan used to say the United States was viewed around the globe as a shining house on a hill. Asia could soon be reminding Americans who holds the deed.
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