from Follow the Money

Should China buy Countrywide?

December 3, 2007

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Morgan Stanley’s Stephen Jen seems to think so.  He writes in his most recent (and very wide ranging) note:

“We all know that SWFs [sovereign wealth funds] will have a very difficult time in the future, because of their vilified reputation.  Buying cheap, strategic assets and appearing to be rescuing the US will carry immense long-term reputational benefits.  More SWFs should jump in now, in my view.  Countrywide would not be a bad choice.  How much does it cost?  Three weeks’ of reserve growth for China?  Also, this may be the best time to buy US banks and financial institutions, as there would be the least political impediment to such inflows. “

I can see the logic.   Chinese investment abroad has often been designed to help secure the supply of key resources China needs.    Raw materials are the obvious example. 

But given the pace of China’s reserve growth – and I very much agree with two other points Jen makes, namely that China’s reserve growth hasn’t really slowed despite the October data and that the kind of large appreciation now needed to end speculative inflows into China is politically infeasible – China also needs to secure a “safe” supply of reserves assets.

And so long as the RMB tracks the dollar, a safe supply of dollar assets. 

There are likely limits to the number of Treasuries and Agencies that even China wants to hold.  

So why not buy a mortgage originator?

China could internalize the incentive problems in the “originate and distribute” model by owning its own originator and distributor.    China might even be able to find someone willing to run Countrywide for a bit less than its current CEO … 

A Chinese Countrywide would, presumably, only make the kinds of loans that Chinese investors would want to buy.  The CIC would get the profits associated with creating mortgage-backed securities for the State Administration of Foreign Exchange to buy.

If nothing else, it would make the role Chinese demand for US bonds has played in supporting the US mortgage (and thus the housing market) explicit.

Jen though also notes that the CIC is likely to be kind of cautious –

“CIC’s Chairman Lou Jiwei said last Friday that there are institutional constraints for the CIC to make large investments in the near term, and that much of the investments are likely to be ‘beta’-oriented financial portfolio investment …  We need to keep in mind that CIC is only two months old, and is still in the process of staffing its investment teams.  Also, its experience with past investments may force it to be a bit more cautious/risk-averse in the near future.” 

Having gambled and (so far) lost on Blackstone, China is unlikely to gamble on Countrywide.   At this point, buying Countrywide means buying its existing portfolio … not just its origination business.  I am not sure any Chinese financial institution -- let alone the CIC -- wants to take that risk right now.  

The deep irony, of course, is that five years ago, many outside observers assumed that China's state banks were stuffed with so many bad loans that they would have to be sold off to US and European banks.    Privatization was associated with financial progress -- and financial modernization.  Now, by contrast, large stakes in US and European financial institutions are being sold to the very same Chinese state banks ...  and others are turning not to the private market but to state investment funds in the Gulf for a bit of extra capital.  

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