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Analysts: US bailout 'positive' move for markets

By Xin Zhiming (China Daily)
Updated: 2008-09-09 07:08

The government takeover of beleaguered mortgage finance giants Fannie Mae and Freddie Mac will benefit its debt holders, but could pose questions for major holders of US treasury bonds, such as China and Japan, analysts said.

But the central bank described the move as positive. "Chinese investors have a certain amount of exposure" to the companies, Zhou Xiaochuan, governor of the central bank, said Monday.

"I think they welcome the new policy, but we still need time to have a further study. From my point of view, I think this is positive."

The de facto nationalization of the financial heavyweights will anchor the US and global financial market, analysts agreed. "It is good news for Chinese holders of mortgage-backed debt in the two companies," said Dong Yuping, an economist with the institute of finance and banking at the Chinese Academy of Social Sciences. "If the US government hadn't extended a helping hand, their insolvency would have brought serious losses to Chinese holders."

The deal was also done to prevent the government-sponsored companies from being declared insolvent, so it clearly benefits bond holders, said Stephen Green, a senior economist at Standard Chartered Bank in Shanghai.

The two companies account for $5 trillion worth of mortgages in the US - about 40 percent of its national total. Some $1.5 trillion of the debt is held by foreign investors.

At the end of June, Chinese commercial banks held a total of $24 billion in the mortgage-backed debt of Fannie and Freddie. Bank of China alone held more than $17 billion. They began reducing their holdings after the US subprime crisis broke last year.

"Since the US government intervened, the risks for Chinese holders have become fairly marginal," She Minhua, a Shanghai-based economist, said.

But the government bailout will not improve the US housing market's fundamentals, and the underlying risks from the market will remain, Dong said. "They (the government measures) will only work temporarily to stabilize market sentiment."

The housing market is still suffering from increasing payment defaults and more funds are needed to fill the gap, he said. As the government uses fiscal resources to bail out Fannie and Freddie, taxpayers may deem it necessary to save for future contingencies, affecting consumption.

Moreover, after it takes over the problematic mortgage companies, the US government will have to find ways to pool resources to inject into them. It has promised to inject up to $100 billion into each as needed to ensure they can meet debts. It would also buy mortgage bonds backed by these companies, starting with an initial $5 billion purchase, and provide an unlimited liquidity facility until the end of next year.

"It may pool the money through issuing new treasury bonds," Dong said. But as China's holding of US treasury bonds depreciates on the declining dollar, it faces a dilemma over whether to increase holdings.

China and Japan, the largest holders of US treasury bonds, have a hard decision to make, Dong said. If they increase their holdings, no one knows where the market will head for. If they don't, their asset value may continue to fall.

China is believed to hold about $500 billion worth of US treasury bonds. "The challenge for China is that it cannot simply sell its official agency holdings, even if it wanted to. Given that it holds such a large amount, that would be a huge international market event and would do serious harm to the dollar," Green from Standard Chartered said.