from Follow the Money

It seems like so long ago ... documenting the role foreign central banks played in the US decision to backstop the Agencies

September 27, 2008

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It is hard to believe that only three week have passed since the US government effectively took over the Agencies. Friday’s Wall Street Journal provided something of a post-mortem. And it sure seems like a fall in central bank demand for Agency bonds played a key role in at least the timing of the Treasury’s decision to take over the Freddie and Fannie. Jessica Holzer reports:

Mr. Lockhart said that by August, the firms’ borrowing costs were climbing higher and it became clear the firms wouldn’t be able to raise capital in any "meaningful size." Meanwhile, central banks had stopped buying their securities, while ratings firms had notched down their ratings on all but the companies senior debt.

These factors "convinced us that the time to act was now," he said.

Lockart is the director of the Federal Housing Finance Agency.

China -- by far the largest official holder of Agency bonds -- also seems to have expressed its concerns directly to the Treasury. Harden and Cha of the Washington Post report that Chinese officials told the US to do "whatever is necessary to protect their investments."

They wrote:

"In recent weeks, finance chiefs from around the world have come to consult with their counterparts at the Federal Reserve and U.S. Treasury about possible interventions.

China’s delegation, headed by a 60-year-old ex-banker who comes from the country’s depressed coal-mining region, has been among the most vocal, according to sources briefed on the discussions. China has a direct interest in the U.S. crisis. It is estimated to hold a fifth of its currency reserves -- as much as $400 billion -- in Fannie Mae and Freddie Mac debt. In addition, its banks have billions of dollars worth of exposure to the American International Group, Merrill Lynch, Lehman Brothers and other companies in crisis. The Industrial and Commercial Bank of China, for example, has $151 million in bonds issued or linked to Lehman; China Merchants Bank has $70 million of Lehman bonds; and the Bank of China has $75.62 million of Lehman bonds.

As U.S. officials were deciding in August whether to take over Fannie Mae and Freddie Mac, the Treasury Department held informal talks with officials from the People’s Bank of China, the country’s central bank. At that time, investors in Fannie Mae and Freddie Mac in China were dramatically reducing their holdings. The U.S. side told China that a cash infusion was in the works; China said that it expected the U.S. government to "do whatever is necessary" to protect the investments."

China’s concerns are understandable: its holdings of US Agency bonds exceed 10% of its GDP.

Both Lockhart’s testimony and China’s lobbying of the Treasury are consistent with the story I told based on the Fed’s custodial holdings, namely that central banks weren’t willing to trust Paulson’s bazooka. And they seem to have been a big enough player in the market to offset ongoing Agency purchases (I would assume) from the largest US bond fund ...

The august TIC data on Agency holdings will be interesting; the fall in foreign demand for Agencies in the July data was much sharper than the fall in the Fed’s custodial holdings.

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