Bank of China Cuts GSE Holdings by 25%

We wrote yesterday about Japanese retail and institutional investors exiting Freddie and Fannie holdings, and didn’t consider it as worrisome as it might seem on the surface, since at this juncture, the funding of our current account deficit is coming almost from central banks and to a lesser degree, sovereign wealth funds.

Tonight, the Financial Times reports in “Bank of China flees Fannie-Freddie,” that the Bank of China has cut its Freddie and Fannie positions. Although it went public in 2006, state entities still have majority control, and the bank is generally described as a state-owned bank. Thus one must wonder if the bank’s move is an early sign of changing official sentiment.

Doc Holiday commented yesterday that the low yields on Treasuries relative to inflation constituted a huge, largely unrecognized bubble. The FT provides a possible explanation. In the last month, foreign investors were sellers of Agencies and made much-larger-than-usual purchases of Treasuries.

From the Financial Times:

Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June.

The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.

Foreign investors have been a mainstay of the market for such debt, but uncertainty over the mortgage financiers’ capital positions and the timing and structure of a potential government rescue has made some investors reassess their exposures. Asian investors in particular have become net sellers of agency debt, said analysts.

Federal Reserve custody data shows that for the year to July, foreign official and private investors bought an average of $20bn of agency debt a month, including debt issued by other government agencies such as Ginnie Mae and the Federal Home Loan Banks. Purchases of US Treasuries averaged $9.25bn.

From July 16 to August 20, foreign investors sold $14.7bn of agency debt, trimming their overall holdings to $972bn. They purchased $71.1bn of Treasuries in the same period…..

This weekend, the Group of Twenty developed and advanced developing countries will be holding a preparatory meeting in Brazil. Although the crisis at Fannie Mae and Freddie Mac is not on the agenda, there is speculation that Treasury officials could informally encourage big holders of agency debt and mortgage-backed securities not to scale back their investments..

We’ll see in the next few weeks if the sales campaign succeeds.

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  1. dan k

    The Chinese are merchantilists, but even they will eventually figure out that the dollars they crave are an “asset” that keeps on taking – compounded negative interest. At some point, interest rates above 10%

  2. etc

    dan k,

    At long as the political benefits the Chinese derive for the slice of their population that owns or works in the export sector exceeds the losses on investments in treasuries, the Chinese will stick with its mercantilist currency policy. Thus, you can’t say any particular level of currency losses is big enough for them to change their way, without calculating the political benefit they derive.

    Also, if they have a goal of hurting US power by making the US so indebteded it suffers the way Germany did after WWI, query how long this could go on. Sort of like force feeding a duck enough to kill itself in order to make a delicacy.

  3. S

    Agree bond market is the most substantial bubble out there. The equity market is a diversion. If the bond market explodes the funding window closes. Look for US gov to take every conceievable measure to keep it open, regardless of who gets run over in the process. Note that the massive issuance of short dated debt as the US tries to arb the artifically low rates thet they themselves set. It is beyond comprehension that such behavior is condoned, let alone legal. Imagin if you could set your cost of capital, work to artificially supress it further and impose the stealth and insidious inflation tax on the poplulation. Yves you are 100% correct in calling the US a banana republic.

  4. Danny

    US treasuries are so low because we are entering a deflationary bust. Anybody who shorts treasuries is going to get hammered. Yields are going to collapse.

    The dollar isn’t going to collapse this go round. It very well might in the next decade, but not now. Everyone crows about our deficits, etc. (I certainly do), but how can those not be priced in when movies like IOUSA get so much coverage? That is as contrary an indicator as I can think of.

    I will short the dollar and expect its collapse when everyone doesn’t, because thats when it’s most likely to happen.

  5. Anonymous

    What else will they do with it?

    Reallocating to Beijing cartoon character collectibles: Chinese prime minister Hu Jintao, quoted in _China Daily_ “Well, we seem to have a lot of these Fannie things around. Don’t get me wrong, I love a little Fanny now and then, but I’ve heard about some opportunities to buy these Beijing Olympic character costumes and ON THE CHEAP. Wave ’em in! I just lifted 3,000,000 retarded space age panda stuffed animals for like 200 yuan!

    Hu’s the man now dawg?

    Hu’s the man now dawg?

    Hu you talkin’ to Willis?

    Hu’s on first?

    No, Hu’s on first!

    That’s right Hu’s your Baba now, Gege?

  6. Matt Dubuque

    Hey Danny, a deflationary burst looks like the most likely scenario, glad you agree with my assessment!

    A couple of key points here.

    The Olympics are over. Now the Chinese will play hardball.

    Although the US may not understand it, China’s grand design is to reintegrate “the motherland”. Tibet, Hong Kong, Macao basically leaves one final domino (other than the Spratly Islands).


    Taiwan is on the back burner of every American politician.

    It will obviously be in the headlines in the future and I suspect the date will be far sooner rather than later.

    And our economic destiny will surely be held hostage to that demand.

    Deficits suck.

    Matt Dubuque

  7. Anonymous

    S said
    “Note that the massive issuance of short dated debt as the US tries to arb the artifically low rates thet they themselves set.”

    Can you please explain this in a little more detail?

  8. leftback

    Danny and Matt,


    Treasuries are the place to be right now. These busts don’t all happen at once, the events are sequential. When equities collapse (weeks and months now, not years), money will flow into Treasuries, then corporate bonds will be the next to go. Eventually, there will be forced reflation that will kill the $, and then and only then, Treasuries will sell off. It is all about layers of risk.

    I actually know people who are long stocks and short Treasuries. But they are so hubristic that I cannot feel sorry for them.

  9. Anonymous

    Congress, with the complicity of the White House and the Fed, has arguably embarked on a stealth repudiation.

    In his famous treatise, “The Wealth of Nations,” Adam Smith noted there had never been a “single instance” of sovereign debts having been repaid once “accumulated to a certain degree.” We may have reached Smith’s threshold.

    We are at a Smithian moment, in which the temptation for the Fed to spend its last dime of credibility may prove irresistible. Investors are already being taxed by inflation and can rationally expect that tax rate (the inflation rate) to be raised going forward. Wages are not keeping up. Main Street is being taxed to fund Wall Street excess. Anyone who works, saves and invests is exposed to confiscation of his capital and earnings through inflation.

    If the Fed maintained its independence of action and said no to the inflationary finance of Congress’s profligacy, we wouldn’t have reached this point. But the Fed has forsaken that independence amid an absence of leadership.

  10. Anonymous

    We’re back to that ‘internal’ funding of debt if you can’t get a crutch from outside sources. It’s not that foreigners can’t get a decent rate of return but are worried about default or incurring (more)devalued paper.

    Short term T-bills accumulation indicates short term thinking because the long term outlook is unbearable.

    The banking system in place was/is made to inflate, plan accordingly.

  11. Anonymous

    PLEASE can we get the collapse in full swing. The constant terrible economic news is wearing thin. Let’s get the rebuilding started.

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