Overseas debt drives bailout of Fannie, Freddie

CHARLOTTESVILLE | Foreigners own a big chunk of the debt issued by America’s two mortgage giants, broadening the fallout of any failure beyond U.S. borders and giving the Bush administration one more powerful reason to take over Fannie Mae and Freddie Mac.

As the bailout announced over the weekend is now structured, the more than $1 trillion in Fannie and Freddie debt securities held by investors in China, Japan, Europe and the Middle East would be protected even if the two mortgage giants fail. U.S. banks that bought similar debt would also be protected.

But major U.S. banks that bought preferred and common stock in the mortgage giants may only recover a fraction of their original stake. Those banks watched helplessly as their investments dropped to pennies on the dollar by Monday.

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“I suspect this is the first case where foreign central banks exercised their leverage as creditors to push the U.S. government to make a policy decision that protected their interests,” said Brad Setser, a fellow in geoeconomics at the Council on Foreign Relations, who has tracked rising foreign investment in Fannie, Freddie and other debt issued by U.S. agencies.

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At a conference of former finance ministers and officials in Charlottesville on Monday, many argued that Treasury Secretary Henry M. Paulson Jr. had to act, given the high level of foreign ownership of Fannie and Freddie securities.

The consequences of a default on Fannie Mae and Freddie Mac securities around the world “would have been devastating,” said John Snow, Mr. Paulson’s predecessor.

“There is relief around the world that the U.S. government is standing behind this paper,” Mr. Snow said.

“The U.S. has long been a source of stability. The U.S. has now emerged as a source of instability, not just in the U.S., but in world markets,” said Peter Costello, the longest-serving treasurer in Australia’s history, who left office last year.

Foreign investors assumed that securities issued by the U.S. mortgage giants came with an implicit backing from the U.S. Treasury, Mr. Costello said.

“The U.S. government had no choice,” he said.

Mr. Paulson, in an interview with CNBC on Monday, said foreign pressure was not the “major driver” of the takeover, but acknowledged that “there’s no doubt that there’s fragility in the capital markets.”

“These companies are so big, and they are owned by investors all around the world. You are obviously going to get concerns,” Mr. Paulson said. “It was definitely concerning overseas, but there was concern in this country. I tell you, my phone is ringing the most from investors here.”

China’s central bank praised the U.S. move Monday in a statement posted on its Web site.

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