from Follow the Money

China has lost its appetite for risky assets

December 30, 2008

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George Chen of Reuters reports that both the CIC and SAFE are scaling back their investment in risky assets. Word has come down from on high.

China’s foreign exchange watchdog, the State Administration of Foreign Exchange, will cut back on overseas equity buys next year after suffering major losses on the collapse of U.S. lender Washington Mutual, according to sources. ..

The big losses by SAFE in the WaMu deal through its investment in the TPG fund have drawn attention from top government leaders in Beijing, who have urged both CIC and SAFE to be more cautious on its overseas investments next year. CIC has already attracted massive criticism at home over its deals in U.S. firms, which have been battered by the credit crisis, with its stakes in private equity house Blackstone Group (BX.N) and Morgan Stanley (MS.N) diving in value. One of the sources said both CIC and SAFE would focus more on overseas investments in fixed income areas rather than equities deals in 2009.

Right now it actually seems like China isn’t willing to any risks period. That includes buying bonds with some credit risk. Over the past few months, China seems to have bought little other than Treasury bonds -- and perhaps some German bunds and other high-quality Euro-denominated bonds.

It is mathematically impossible for China not to account for a very large share of the Fed’s custodial holdings of Agencies -- and those holdings continue to fall. They are now down for the year. They were way up in July, so this is a huge swing. And conversely the growth in central banks Treasury holdings is truly incredible. Think of a $450 billion increase in a year -- an increase far in excess of the increase in 2004 when it seemed like Japan was buying every Treasury bond it could find.

I would bet that the CIC is privately pleased that SAFE took a loss on its investment through TPG in WaMu. TPG apparently wanted the CIC to participate, and the CIC said no. SAFE didn’t. George Chen again:

Sources said TPG initially approached China Investment Corp, lobbying the country’s official sovereign wealth fund to become a major limited partner of its new private equity fund. CIC, which was set up by the Communist government last year to earn higher returns on a $200 billion portfolio of its foreign exchange reserves, declined the offer mainly due to concerns about investment risks and poor prospects of U.S. markets, the sources said. Instead, TPG’s dealmakers contacted SAFE and the foreign exchange regulator agreed on condition that TPG would also jointly invest some of its own money in the WaMu deal, the sources said.

SAFE’s associated losses should make it a bit harder for SAFE to argue that it can knows how to manage risk more effectively than the CIC.

SAFE can point to the CIC’s ill fated investments in Blackstone, Morgan Stanley and the Reserve Primary Fund. But the CIC can now point to SAFE’s losses on WaMu -- and its (still hidden, I think) mark-to-market losses on its broader equity portfolio.

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