The US Treasury Department’s announcement Sunday it would bail out and effectively take over troubled government-sponsored enterprises Fannie Mae and Freddie Mac is good news for US homeowners. But as Daniel Gross points out in his always excellent Slate magazine Moneybox column
, it’s even better news for the People’s Bank of China.
According to Gross, Treasury’s key concern over the impending collapse of the mortgage behemoths was not US homeowners but the impact it would have on the international financial system and the central banks and foreign institutions that have "bought their debt by the boatload”.
Gross uses the Federal Reserve quarterly flow of funds
to show just how exposed central banks around the world were to the debt of Fannie and Freddie. In 2003, non-U.S. investors held $654.8 billion, or 8%, of all agency or government-sponsored enterprise debt, divided among official investors like central banks ($262.9 billion) and private investors ($391.8 billion). Five years later, by the first quarter of 2008, foreigners held $1.54 trillion in such debt, or 21.4% of the total, with official authorities holding $985 billion, or more than three times their holdings just five years earlier.
Why the surge? As Gross explains, China’s central bank, petrogovernments in the Persian Gulf and other big international players like sovereign funds use the dollars they get when US consumers buy their exports – oil, manufactured goods etc – to buy dollar-denominated assets such as Treasury bonds. When the Federal Reserve slashed interest rates a few years ago, Treasuries became less attractive and foreigners began buying debt issued by Fannie Mae and Freddie Mac. The government-sponsored enterprise status of the lenders gave an implicit guarantee that the debt instruments not only paid a higher interest return but were also just as safe as US government bonds.
Hindsight being 20/20, we now know it wasn’t just as safe. But where the Treasury could justifiably sit back and allow a normal US bank to fail – “If individuals default on their mortgages and get foreclosed on, that's their proper comeuppance. If subprime lenders go out of business, that's capitalism's creative destruction. If banks start to fail, as they're now doing at a rate of one per week, no big deal” – it couldn’t pass the buck on Freddie and Fannie.
It is tempting to say that China's central bankers are big enough and ugly enough to also take the hit for their misjudgement. But Treasury wasn't bailing out the mortgage lenders simply to do China a favor. It was also looking after number one, well aware that it’s already soiled international financial standing would not withstand the hit it would take if the Treasury also managed to cripple central banks in China, the Persian Gulf and elsewhere through its fiscal mismanagement. Saving Fannie Mae and Freddie Mac was the price the Treasury had to pay to preserve whatever remnants of US pride it had left.
China’s central bankers will be breathing easier, grateful that saving face is not solely a Chinese preoccupation.