Russia Urged China To Dump Its Fannie, Freddie Holdings Before GSE Bailout
This is how the cold war will look like in the post-Lehman era (when all the debt risk is held on the public balance sheet): one country urging another to sell a third's bonds. According to Hank Paulson's soon to be released memoir, Russia had urged China to sell its GSE holdings in August 2008 "in a bid to force a
bailout of the largest U.S. mortgage-finance companies." China refused... That time. Of course, what has transpired since is that China, through the Fed custodial account, has rotated a vast majority of its GSE holdings into Treasuries, in essence doing just what Pimco's Bill Gross has been doing since the beginning of 2009: offloading hundreds of billions of Fannie and Freddie bonds straight to the Federal Reserve. Alas, the Fed is 93% done with MBS QE... What happens when residual selling of bonds finally hits the public market, and the bottom falls out?
The Russians made a “top-level approach” to the Chinese
“that together they might sell big chunks of their GSE holdings
to force the U.S. to use its emergency authorities to prop up
these companies,” Paulson said, referring to the acronym for
government sponsored entities. The Chinese declined, he said.
Paulson learned of the “disruptive scheme” while
attending the Beijing Summer Olympics, according to his new
memoir, “On The Brink.”
“The report was deeply troubling -- heavy selling could
create a sudden loss of confidence in the GSEs and shake the
capital markets,” Paulson wrote. “I waited till I was back
home and in a secure environment to inform the president.”
Of course, the Russians were very prophetic, with the formal GSE conservatorship announcement following a few short days later on September 6, 2008. They also knew how to put their money where their mouth was:
Russia sold all of its Fannie and Freddie debt in 2008,
after holding $65.6 billion of the notes at the start of that
year, according to central bank data. Fannie and Freddie were
seized by regulators on Sept. 6, 2008, amid the worst U.S.
housing slump since the Great Depression.
The implications of this revelation are troubling, as in a newly multi-polar world, in which China is now the second largest economy, and merely needs a block of one other major power, be it Russia or Japan, in order to precipitate a selloff in critical U.S. securities, be they MBS (not so much these days), or, more relevantly, Treasuries.
Curiously, the bailout of the GSE was based on the premise that placating China and other major US security holders (both in the public and private arena) is critical. It explains the lack of impairment of both the Sub debt in the GSEs as well the sub debt in all the bank holding companies. If indeed China had been considering selling its bonds, it means that it had likely approached the proper senior level officials with its concerns, and could have been a material influence in bailout policy in the days surrounding the Lehman collapse. Which makes an even bolder case for the observation that the U.S. is nothing more than a vassal state of its largest creditor: if China can dictate domestic policy, which these days typically amounts to yet another bailout decision, then why do Americans need to pretend their government is at all relevant any longer?