July 15 (Bloomberg) -- Lenders to Fannie Mae and Freddie Mac were being skittish for no reason.
The risk premium on the beleaguered mortgage financiers' debt began rising in May and was, until last week, headed toward levels seen before the collapse of Bear Stearns Cos. in March.
Equity investors, not knowing how an eventual rescue will affect their interests, had reason to be nervous. Bondholders' pessimism was uncalled for.
The latter, after all, had China on their side.
And that means a lot.
Even if commercial creditors harbored any doubts about the intent or ability of Henry Paulson and Ben Bernanke to save Freddie and Fannie, they shouldn't have expected China to twiddle its thumbs, accept a big loss and still be willing to provide more capital to the U.S.
Foreign central banks, led by China and Russia, hold at least $925 billion in U.S. agency debt, including bonds sold by Freddie and Fannie, according to official U.S. statistics.
That figure ``is almost certainly an understatement,'' says Council on Foreign Relations economist Brad Setser, who estimates the total is more likely to be about $1 trillion, or a fifth of outstanding agency debt.
The so-called government-sponsored enterprises are too big, too vital to housing and too important to the Chinese ``for their debt ever not to be honored on time and in full,'' Setser says. Other economists say the very reason behind the rescue plan is to prop up the debt.
`Limited Amount'
``In the short term, it's been critical to support GSE debt -- key to the value of the dollar and held by all sorts of central banks,'' said a report by Washington-based Federal Financial Analytics Inc.
Russia's Finance Ministry issued a statement yesterday saying it had placed a ``limited amount'' of its international reserves -- though none of its oil riches -- in U.S. agency debt.
Not a word from China.
Not only does China hold a lot of these securities, it has, of late, been buying them with gusto. In the 12 months through April, official Chinese additions of U.S. agency debt -- purchases net of sales -- amounted to $67 billion, a 26 percent increase from a year earlier.
Ever since the bailout of Bear Stearns, China must have been doubly confident that Freddie and Fannie weren't going under: Sooner or later, Treasury Secretary Paulson and U.S. Federal Reserve Chairman Bernanke would ease the crisis of confidence by making the implicit government guarantee on agency debt explicit.
Perfect Outcome
From China's perspective, Paulson's ``Three-Part Plan for Immediate Action'' is a perfect outcome if it succeeds in lowering the risk premium on Freddie Mac's 10-year debt over U.S. Treasury notes of similar maturity. The capital gains that this narrowing of spread will produce for China will be quite a bonanza. The process may already be under way: The excess yield fell to 73 basis points yesterday from 94 points on July 10.
Paulson's comments about a possible recapitalization of Freddie and Fannie helped the U.S. dollar to strengthen in Asian trading yesterday. If the dollar rally is sustained, the yuan, up almost 7 percent this year, may get a breather from further appreciation. China's increasingly vociferous pro-growth lobby, complaining about the loss of export competitiveness, may be able to rest a little easier.
The yuan dropped for the first time in three days yesterday.
Beginning of End?
Finally, if the resolution of the Freddie/Fannie saga marks the beginning of the end of troubles in the subprime-ravaged U.S. financial industry, that will mean good news for China Investment Corp.: The sovereign wealth fund's stakes in Blackstone Group LP and Morgan Stanley have shriveled since China Investment picked them up in May and December last year, respectively.
At present, this is a bit far-fetched.
There's little reason to believe that the worst in the U.S. housing crisis is over.
Analysts at Goldman Sachs Group Inc. and CreditSights Inc. warned of dividend cuts and additional capital-raising plans at U.S. regional banks, following the collapse last week of IndyMac Bancorp Inc., a California mortgage lender.
Besides, to the extent the U.S. has to resort to using real money to shore up confidence in Freddie and Fannie, the result may not be all good for China. A key risk is that Paulson's bailout plan may expand the U.S. budget deficit, which may be inflationary and push Treasuries lower.
At last count, China owned $502 billion in Treasuries. Including agency debt, its holdings are more than $1 trillion, about a quarter of China's gross domestic product, Setser says.
Will China panic and dump U.S. assets? Perhaps not.
Like most of China's economic policies, the nation's approach toward reserve diversification will also be gradualist. With China's reserves reaching $1.8 trillion in June -- a $280 billion increase this year -- Freddie and Fannie, even after losing their yield premium, are assured of the Asian country's reluctant patronage.
p.s. Sorry I can't read the full article in your 2nd link. |
