With Fannie and Freddie Out, China May Take Hard Hit

By Michelle Yu, Epoch Times
February 16, 2011 8:23 am Last Updated: February 16, 2011 1:09 pm

The Obama administration proposed on Friday the wind-down of once government-sponsored mortgage buyers Fannie Mae and Freddie Mac. Analysts say China, as a major bond holder of the two companies, may suffer significant losses as a result.

Shortly before the Obama proposal, economist Lu Zhengwei at China's Industrial Bank Co said in a report that Chinese institutions may be holding about US$500 billion worth of bonds issued by Fannie Mae and Freddie Mac. He warned of the risks of holding Fannie and Freddie bonds. Lu suggested China should reduce its holdings.

Lu’s article has been widely quoted by Chinese and international media. Though China's State Administration of Foreign Exchange (SAFE) refuted the estimation as “groundless,” without citing Lu’s report, it is generally suspected that the number is not far from the truth. Lu told Dow Jones Newswires his estimation is based on Chinese media reports.

According to the U.S. Treasury's report on foreign holdings of U.S. securities, China held US$454 billion of long-term U.S. agency debt as of June 30, 2009. That included US$358 billion of asset backed securities backed primarily by home mortgages, and US$96 billion of other long-term agency debt, according to the Dow Jones Newswires.

“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,” the Dow Jones Newswires reported.

In addition to government foreign exchange investments, some Chinese financial institutions also purchased Fannie and Freddie bonds. For example, Bank of China said in its 2010 mid-year report that it held US$819 million worth of Fannie and Freddie bonds, and US$1.66 billion mortgage bonds guaranteed by Fannie and Freddie–both numbers are book values.

Lu said though an outright default is unlikely, the wind-down of Fannie and Freddie could cause the price of the securities to fall.

U.S. financial analyst Ding Li agreed with this assessment. He told The Epoch Times that China’s actual loss will depend on negotiations by all involved parties.

Some analysts question the reason behind China’s excessive purchases of Fannie and Freddie bonds.

Hong Kong financial expert Lew Mon Hung said in an article on inmediahk.net that China’s investment in the two companies is 16,000 times as high as India’s.

Lew, member of the Chinese People's Political Consultative Conference, said he suspects some decision makers may have embezzled the transaction commissions associated with the Fannie and Freddie bond purchases.