Foreign treasuries just starting to notice U.S. debt catastrophe

Steps Taken to Calm Investor Fears Over Agency Debt

By Jamil Anderlini, Charles Clover, Krishna Guha, Kathrin Hille, Song Jung-a, Michiyo Nakamoto, James Politi, Saskia Scholtes, and Henny Sender
Financial Times, London
Thursday, July 24, 2008

http://www.ft.com/cms/s/0/1abb233e-5918-11dd-a093-000077b07658.html

Last Thursday the Kuwait Investment Authority, the world's sixth-biggest sovereign wealth fund, received a call from the US embassy to reassure them that bonds issued by Fannie Mae and Freddie Mac were sound, according to one person with knowledge of the matter.

The call came after Kuwait's minister of finance announced that the KIA was not planning to invest in Fannie Mae and Freddie Mac debt in future.

The Treasury was unable to comment on the specific episode but said US officials had been in contact with other governments throughout the market turmoil as part of their regular responsibilities.

"This certainly includes providing information on the steps we've proposed to provide temporary authorities to give confidence to markets and create a strong, independent regulator for the government-sponsored enterprises [GSEs]," said the Treasury.

Foreign investors -- particularly in Asia and Russia -- have been among the biggest buyers of so-called agency debt, which they viewed as a safe investment. In recent years this debt served as an important conduit for recycling global trade and petrodollar surpluses into US housing investment.

A key objective of the rescue plan winding its way through Congress is to calm global nerves shaken by the plunge in Fannie and Freddie stock prices. The plan appears to be succeeding for now, but an undercurrent of unease remains.

"Two weeks ago there was nothing more stable than Fannie Mae and Freddie Mac. These were not considered risky assets. In the last 1 1/2 weeks we have seen this view corrected," Alexander Vinokurov, chief executive of Kit Finance, a Russian investment bank, told the Financial Times.

Executives at many sovereign wealth funds believe the Federal Reserve and US Treasury have lost credibility with international investors in recent months.

If foreign governments were to scale back their buying of GSE paper, even at the margin, it could have a significant effect on US mortgage rates.

A senior Fed official told the FT: "Central banks are asking themselves, 'Where is the upside?' They are increasingly thinking about and questioning the size of their holdings and the rationale behind those holdings."

Still, most financial officials contacted said they were reassured by the strengthened promise of government support for Fannie and Freddie. Chinese officials and government economists said Beijing was satisfied with the moves to prop up the agencies. China may hold as much as $400 billion to $600 billion in Fannie and Freddie debt, most of which is held by the State Administration of Foreign Exchange.

Bank of China has an estimated $20 billion in Fannie and Freddie debt, according to investment bank CLSA. Li Lihui, the bank's president, said the bank "will be able to fully manage the risks related to this matter."

Kang Sung-kyung, head of the Bank of Korea's reserves management planning team, said: "We don't think that we are exposed to big credit risks with our investment in the agency papers."

Meanwhile in Japan the Financial Services Agency denied reports that it was discouraging banks from investing in Fannie and Freddie debt.

"Generally speaking, we have been encouraging banks not to invest in products simply on the basis of a triple-A rating, but we do not tell financial institutions what they should or should not invest in," an FSA representative told the Financial Times.

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