Too Chinese to fail? It's must be a fake theorem. I always say that US couldn't bear the failure of Freddie Mac and Fannie Mae, and China should not pay the bill for American subprime crisis.
Fannie Mae and Freddie Mac may not have many friends these days, but they should be able to count on a certain loyalty in Beijing. China is the biggest foreign holder of debt issued by the troubled enterprises and a relatively captive buyer of the paper.
US Treasury data shows that mainland Chinese investors owned $376bn of agency long-term debt at the end of June last year, almost one-third of total foreign holdings of the agencies. Virtually all of this is probably held by an agency under the central bank which oversees the bulk of reserves. Extrapolating on the basis of China's growth in foreign assets, economist Brad Setser reckons the country now holds $500bn-$600bn worth of agency paper, or a 10th of the outstanding stock of agency debt.
Rather than sticking with straight debt, SAFE has been shovelling up the agencies' asset-backed securities
– at the end of June last year, China held $206bn. That may well be harder to dump. Even in more normal times, commercial banks – the other natural buyers – often have balance sheet constraints. Pricing is also more sensitive to changes in market rates.
In future, switching into different instruments could also prove a struggle for China given the volumes involved. Replacing annual purchases of $150bn or so of agencies with alternatives is tough. Buying more Treasuries would impact yields, while moving into corporate bonds would ratchet up risk. That is something which China, still smarting from big paper losses in Blackstone and Morgan Stanley, is presumably keen to avoid. These US investments were both, in a roundabout way, funded by foreign exchange reserves. None of this makes government-sponsored enterprise debt especially compelling, but it does make China's central bank a very attractive buyer.
The People's Bank of China as America's lender of last resort? Now that really would give Messrs Paulson and Bernanke food for thought.
