China’s future with Freddie & Fannie
In case you live under a rock, Henry Paulson, the United States Secretary of the Treasury, and Jim Lockhart, director of the FHFA, announced on Sunday that the U.S. Government was placing mortgage giants Fannie Mae and Freddie Mac under a conservatorship. Essentially, the treasury took $1 billion in preferred senior stock in both companies. The common shareholders are now last in line for claims; however, the shares will continue to trade on the market.
China’s central banks are one of the top foreign holders of Fannie Mae and Freddie Mac bonds, owning approximately $376 billion of debt issued as of mid 2007. Lately, the Chinese government has been withdrawing their investment in the mortgage companies. The Bank of China alone slashed its exposure from $17.3 billion in June 2008 to $12.67 billion as of August 25, 2008.
Ironically, the GSE bonds state that they are not backed by the U.S. government. Although not officially backed by the U.S. government, the impact of the failure of Freddie and Fannie on the international markets would be disastrous. The bail out was a last resort, one for which the American taxpayers will pay a huge price.
The short-term impact of the bailout was felt immediately on Monday morning when markets around the world soared. The bailout has elicited a positive response from the biggest bondholders of Freddie and Fannie, including the Chinese government. China’s bank stock soared on Monday morning. But is it a short term solution to a long term problem? By Monday evening the Shanghai Index closed at a 21-month low. On the other hand, Bank of China in Hong Kong rose 4.6%.
The Chinese government has claimed their hands are tied. No matter how cautiously and prudently they have acted, they are unable to diversify their $1.8 trillion in currency reserves because of the current state of international markets. According to the Guardian, Chinese Vice Premier Wang Qishan stated non-government dollar bonds would be even riskier, . . . the euro is expensive, . . . and yields in Japan are low. Therefore, China put money into the United States mortgage giants, but even that has turned out riskier than expected.
What can China do? He Fan, an economist with the Chinese Academy of Social Sciences, explained China’s predicament. ”For China, whether or not you buy the new treasuries, there will be losses: if you buy them, you’re getting deeper in the hole; if you don’t buy them, your existing holdings will lose value.” China has already started to pull out. With the U.S. government getting involved, they may decide to change direction.
For now, the bailout is stabilizing the international markets; however, the long term impacts of the bailout are still unclear. What the bail out does demonstrate is that the international credit crisis is far from over.
