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A US government bail-out of foreign investors
September 8, 2008
Hank Paulson’s effort to prop up Fannie Mae and Freddie Mac has various beneficiaries but few gain more than foreign investors.
One effect of the way the quasi-nationalisation is structured is that US institutions may well suffer more than foreign ones. In brief, it is good for overseas central banks and sovereign wealth funds but bad for US regional banks.
The exuberance in non-US markets this morning is a reflection of that fact. The government has had to step in to reassure foreign investors who have become huge buyers of agency debt, but has treated US equity holders harshly.
As Saskia Scholtes and Krishna Guha point out in the FT this morning, US regional banks could well pay the highest price:
Fannie and Freddie’s combined $36bn of preferred stock is widely held by US regional banks. These banks will be forced to take significant write-downs of their holdings.
Few banks have provided detailed disclosures on the extent of their holdings in Fannie Mae and Freddie Mac, but among those that could be most affected are Gateway Financial Holdings and Midwest Banc Holdings. According to recent research by analysts at Keefe, Bruyette & Woods, both banks have exposure that amounts to more than 30 per cent of their tangible capital.
Meanwhile, foreign holders of agency debt including that issued by Fannie and Freddie have been given a cushion. The US government has not given full sovereign backing to senior and subordinated debt but it has provided comfort.
This is very significant for all the foreign investors, including foreign governments and wealth funds that have piled into agency debt over the past 15 years, regarding it as a substitute for US Treasuries.
They did not come up with this on their own. Fannie and Freddie travelled the world to persuade foreign investors that their debt was a good bet. It turns out that they were correct, at least about that.
According to recent Treasury figures, foreign holdings of US agency debt rose from $107bn in 1994 to $1,304bn in June last year. This outstripped the rate of growth of foreign holdings of both US Treasuries and corporate debt.
Recently, however, foreign investors had begun to get cold feet about agency debt. The FT reported last month, for example, that Bank of China had cut its exposure to agency debt over the summer.
Mr Paulson thus found himself with a fait accompli. The federal government had to give reassurance to foreign investors in agency debt if it wanted to avoid chaos in financial markets and a run on the dollar.
It smacks of debt crises past in Latin American countries, where the ultimate pressure for a bail-out came from foreign investors.
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Posted by: Doom and Gloom - [Meatloaf] Yep, we are a third world country | September 8th, 2008 at 6:15 pm | Report this commentThere is a difference with “Latin American countries”. Argentina defaulted in 2001 and Kirchner offered just 30% face to mostly foreigners. There are $17b in holdouts, some with US Court judgements, still waiting to collect. The reason they cannot is because then NSA advisor Rice “supported Argentina” for “National Security reasons”. Then again in September 2006, when CMS Energy prevailed on appeal of a World Bank ICSID judgement for over $170mm, this time Secy of State Rice refused to support CMS, giving Argentina a reason to ignore the judgement. I successfully sued Peru in 1993, prevailing on appeal because of the support of then Treasury Secretary Rubin in March 1997. That was the Clinton administration. The Bush administration, run by defacto president Cheney is different. We believe its because Dick Cheney wants to “preserve for the USA” the option of pulling an Argentina, in the event that “foreign creditors” like China and Japan “demand to be paid”… Of course Paulson, hailing from Goldman Sachs where he built the “GS financial bridge to China”, is loathe to implement this “Cheney plan”.. hence the bailout… of China..et al..
Posted by: pravin banker | September 9th, 2008 at 1:33 am | Report this commentI have had the assumption that ‘pulling an Argentina’ and helicopter-Ben printing money to meet obligations would each have about the same end result.
However, I suppose going the ‘high inflation and bailing out foreign agency paper owners’ - route is easier to take politically.
It also has the benefit of passing the troubles to the next administration.
Posted by: Trish | September 9th, 2008 at 1:48 am | Report this commentI think Gapper is exactly right. This bailout was moreover to prevent a run on the dollar and “chaos” in the world financial markets.
Posted by: Tbird | September 9th, 2008 at 5:15 am | Report this commentI suppose that the price of the exorbitant privilege of seigneurage is having a due regard for the interests of those who’ve accepted your coin. If one wishes to call that a bailout, I suppose one can. I might rather say we’ve avoided, for the time being, the temptation to debase the currency.
And any intelligent master of a mint is aware of perils of coin clipping–even the notorious alchemist Newton, who, I believe, lost his personal fortune in the South Sea Bubble. But Newton’s talents and mathematics were best applied in other activities, rather as the mathematics of the statisticians who modelled the various financially engineered products of the last decade might, in retrospect, have been better applied in other lines of endeavor.
Oh well, once upon a time, the land under the Imperial Palace in Toyko was worth more than the state of California. Now, I hear the Chinese are upset about having fronted the Americans enough money to build 200 aircraft carriers. In retrospect, perhaps fewer gated communities of McMansions and more carrier task forces would have been a good idea.
Posted by: Dwight | September 9th, 2008 at 6:00 am | Report this commentA study of the “recent Treasury figures”, referred to above, produced an article from MIT in June. ‘What Next for the Dollar? The Role of Foreigners’, http://www.voxeu.org/index.php?q=node/1213
The article ends: “If foreigners lose interest in investing in the US, additional reassuring words by Chairman Bernanke and Secretary Paulson, and even coordinated intervention in currency markets, could not support the dollar.”
Luckily at present Japan, China and the UK are still investing in the US. The bail outs of Freddie and Fannie seem designed to assure big lending continues.
On the ‘comments’ concerning Argentina, it was interesting to read the claim that the UN is sanctioning the selective repayment of international debt.
Posted by: Slightly Optimistic | September 9th, 2008 at 10:30 am | Report this commentDavid Ricardo poignently said in the late 18th century;”Finance is a conspiracy against the laity.”
It was with this in mind that when I wintnessed sinking securitized asset pools in late 2002, Cheap Money and raiding the the Commercial Paper Markets were last ditch remedies before the whole thing unraveled.
The Monetarists believe that debt can be repatriated by rolling bad debt into higher coupon paper. Thus, The Argentine Model is alive and well ! Next, rampant inflation, Exchange Controls, and shortages of staples !
Count on it Oh Doubting Thomases !
Posted by: John P. Crowley | September 9th, 2008 at 1:22 pm | Report this commentOne quick thought is that I guess you can sell anything when all of the market commentators/gurus feel comfortable enough to refer to you as “Hank”
Posted by: Clive Corcoran | September 9th, 2008 at 2:27 pm | Report this commentOk so the world economy benefits from this bail out as much as it benefits the US economy. But what the Fed does nothing and lets retail lenders collapse? what then for the US banking system ? what then for the US economy ? what then for the world economy ?
Posted by: Cricket Bats | September 17th, 2008 at 9:24 am | Report this commentWhy cant the oil companies bail out AIG?
Posted by: Sean | September 24th, 2008 at 9:21 pm | Report this commentThe American oil Companies have the Billions to Bail out the bad companies…Why does the Government have to do it?
When Bill Clinton eased banking restrictions, he dished out $8-billion dollars for “community reinvestment loans.” The money just evaporated. When the “creative financing” schemes fell through, as is their wont whenever 30-million Mexican nationals buy inflated properties and default, it left banks in the lurch. Never mind that the aforementioned demographic is the new face of the Democratic Party; the mortgages morphed into “toxic” instruments. Hillary Clinton counted on the loan giveaways to buy votes. Interestingly enough, had Hillary secured the nomination; she, instead of Barack Obama would preside over the bailout. So, why should Americans perpetuate the housing bubble? Because it’s a scam! And, this is its well-timed exit strategy. Where is that $8-bilion plus dollars? The Trilateral Commission and the Bilderbergers took my money; they even stole my car; now they’re coming after you. The bubble is the New World Order, let it burst: http://theseedsof9-11.com
Posted by: Peggy McGilligan | September 28th, 2008 at 5:06 am | Report this commentNothing For Nobody!
Posted by: Bruce | September 28th, 2008 at 10:46 pm | Report this comment