- The Washington Times - Tuesday, September 9, 2008

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.

The U.S. government “should take the responsibility to stabilize the world’s financial markets and protect investors,” the statement said.

China, with its booming export-driven economy, has led a surge of foreign investment in Fannie Mae and Freddie Mac over the past decade, complementing the surge in foreign purchases of U.S. Treasury debt. Foreign holdings of such “agency debt” grew from $107 billion in 1994 to an estimated $1.3 trillion by early 2008, according to the latest U.S. Treasury data.

The vast majority of agency debt was in Fannie Mae and Freddie Mac securities. These securities do not carry the same explicit backing of the U.S. government offered by Treasury bonds, but investors say the Freddie and Fannie debt was often marketed abroad as if it bore the same low default risk.

China was the top holder of such debt with $376 billion, followed by Japan, Russia and the Cayman Islands. In addition, an unknown chunk of Fannie and Freddie securities is thought to be held by sovereign wealth funds - the wholly owned investment arms of governments such as China, Russia and many Middle East oil exporters.

“The U.S. government’s actions will definitely contribute to restoring confidence in financial markets,” said Han Duck-Soo, former prime minister of South Korea.

“Many people were worried, including central bankers and private foreign investors. The U.S. actions will eliminate all those worries,” he said.

Former German Finance Minister Han Eichel said the U.S. mortgage crisis had become a “global crisis.”

“Such easy credit in the world’s largest economy led to problems for all,” he said.

Mr. Eichel expressed confidence that the U.S. government had the resources to deal with the Fannie and Freddie crises, but he worried that smaller countries might not have the wherewithal to address the fallout in similar circumstances.

Even though Congress gave Mr. Paulson the power to organize a bailout in July, there was still some doubt until this weekend whether the Treasury secretary would actually pull the trigger. That left lingering fears in the market over who would ultimately bear the risk of a default by Fannie or Freddie.

Said Australia’s Mr. Costello, “We now know who has that risk: the American taxpayer.”

David R. Sands contributed from Washington.

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