China SAFE Denies It Faces Half A Trillion In GSE Losses

We were wondering how long it would take for China's State Administration of Foreign Exchange (SAFE) to come out with a report refuting yesterday's statement by Lu Zhengwei that China should immediately proceed to start selling its GSE concurrent with today's announcement by the administration that the "Fannie, Freddie model is dead", as well as the supposed upcoming end of QE2 (don't worry, it won't end) which would send fixed income prices much lower. The answer: less than 24 hours... although not really. Dow Jones reports: "China's foreign exchange regulator on Friday denied a media report that said it could face losses of up to $450 billion on its holdings of securities issued by U.S. housing-mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC).  The State Administration of Foreign Exchange's statement didn't specify which report it was denying, but it appeared to be referring to a report on Thursday by Chinese newspaper International Finance News, which said a forthcoming plan from the Obama Administration to gradually phase out the two government-controlled companies could lead to the losses. SAFE said the report was "groundless," and that is has been receiving regular payments of interest and principle on the bonds it holds from the two companies." Well, duh. The alternative is a technical bankruptcy of the US. What, however, was not denied anywhere is that China may and will commence selling GSE notes soon. Especially since as we reported yesterday, it had already been selling out of its GSE holdings for the past two years. And if they start offloading GSEs, what happens to USTs? Although with the Fed now holding over $1.13 trillion in debt, or over 10% more than China, the answer to that question is increasingly irrelevant.

More from Dow Jones:

 At issue are three kinds of Fannie and Freddie securities. The two companies' stock prices have plunged to nearly zero, but SAFE said in its statement Friday that China has never invested in the stock of the two companies, so it hasn't been affected by the decline.

The real concern is over the debt issued by the companies, as well as asset-backed securities that the companies have packaged out of mortgages and sold to investors. However, the Obama administration has committed unlimited amounts of aid to ensure that the firms meet their obligation to holders of those bonds and securities. The commitment has cost U.S. taxpayers $134 billion so far.

Lu Zhengwei, a senior economist at China's Industrial Bank Co. said in his report on Thursday that such reassurance from the Obama administration amounts to an "empty check" without the support of the U.S. Congress.

"However, looking at the current political situation in the U.S., for the U.S. congress to give a clear guarantee on this issue is almost impossible," Lu said.

And since the estimate of China's GSE holdings is woefully old, nobody really knows what kind of market impact a possible commencement of disposition could have.

According to the U.S Treasury's report on foreign holdings of U.S. securities, China held $454 billion of long-term U.S. agency debt as of June 30, 2009. That includes $358 billion of "asset backed securities...backed primarily by home mortgages," and $96 billion of other long-term agency debt. The bulk of those holdings are likely in Fannie and Freddie bonds and securities, though it also includes debt from other U.S. government agencies such as the Government National Mortgage Association.

That said, for the Obama administration to declare the GSE model dead, and expecting a gradual wind down in Fannie and Freddie portfolios, perhaps they can clarify just who they expect on selling these hundreds of billions in annual bonds to, now that China is becoming increasingly ambivalent about holdings GSE bonds, let along buying more.