from Follow the Money

How quickly the world changes

December 20, 2007

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

More on:


My guess is that when Hank Paulson went to Washington, he hoped to be the one who would really open up China’s largely closed domestic financial market to investment from private US financial firms.   Paulson always seemed more passionate about financial liberalization than exchange rate appreciation.  It now seems more likely that by the end of Paulson's tenure as Treasury Secretary, China’s government will have increased the scale of its minority stakes in large US banks and broker dealers while private US firms will still not have majority stakes in large Chinese banks.    

Beijing needs places to invest, not more inflows.  Chinese banks do not need another round of cash from Goldman or anyone else, and wouldn’t sell at anything like the same price.   The Chinese state banks -- and as well as their ultimate owner, the CIC – all have plenty of cash to invest in troubled US banks.   They are exceptionally liquid.

The Bush Administration has clearly opted to focus on the need to keep the US market open to foreign investment of all kinds, including investment from large government funds -- not on the risks of "state control" and the associated challenge to the logic of market capitalism.    That opens up space for China's government and large Chinese state banks to buy into the US financial system. 

Naked Capitalism (happy blog birthday!) has an interesting discussion of the trade that got Morgan Stanley into trouble.  I am not sure I fully understand the details (“long $14B super senior, short $2B mezz “), but it seems like Morgan effectively held seven times as many higher-quality mortgage backed securities (super-senior tranches of CDOs constructed from mortgage backed securities) as it had sold short lower-quality securities (mezzanine tranches of similar CDOs), with the bigger position in the higher quality securities offsetting the interest cost of shorting the lower quality securities.  

If you cut through the correlation analysis -- from the comments at Naked Capitalism: “I heard that they had a correlation delta neutral position of Longer super senior/short junior mezz which would tally with the 14long/2short position you report. Sadly for them in a crisis correlation tends to 1 and they were long correlation on the 2/short on the 14" --  it seems like Morgan Stanley bet that the subprime crisis would be bad (making it worthwhile to be short the lower-quality stuff) but not too bad (in which case the long position on the higher quality stuff would bite).    


Better call China.  

It is a little ironic that some of the banks who were advising US companies that they had too much equity, too much cash and too little debt on their balance sheets for a low volatility world turned out to have too little equity, too little cash and too much debt on their own balance sheets to manage a bit of volatility in the housing market.  


UPDATE:   Maybe I should have said, better call China, the Gulf or Singapore.   It looks like Singapore's Temasek may take a stake in Merrill.   Pretty soon every major sovereign fund will have its own in house bank or broker dealer.   THow quickly the world changes.  In 1997, the US government helped bail out out cash strapped Asian economies; in 2007, Asian government investment funds seem intent on helping to bail out cash strapped American banks and broker-dealers.

More on: