By JASON DEAN in Beijing, YUKA HAYASHI in Tokyo and LAURA SANTINI in Hong Kong
THE WALL STREET JOURNAL ASIA
July 14, 2008
For much of the world, the greatest effects felt from the crisis over Fannie Mae and Freddie Mac may be further deterioration of confidence in global capital markets and in the belief that the U.S. economy or the dollar will rebound strongly anytime soon.
Asian central banks and financial institutions are major holders of U.S. debt and are believed to own substantial portions of debt for Fannie Mae and Freddie Mac. According to the U.S. Treasury Department's latest data, foreigners owned 21.4%, or $1.3 trillion, of the total outstanding long-term debt issued by U.S. government agencies as of June 2007. China and Japan were by far the largest investors in such securities, holding $376 billion and $229 billion, respectively. It isn't clear how much debt either country owns from Fannie and Freddie specifically.
Despite that exposure, widespread belief that the U.S. government won't let the two institutions default on their debt is keeping most observers sanguine about the direct impact of the crisis on Asian bondholders. And stocks of the two mortgage agencies, which have been battered in recent days, aren't widely held in Asia.
But the indirect impact on the Asian-Pacific region could be much worse. Already, turmoil in U.S. credit markets has led to massive losses in global stock prices. Bond issuers as far away as Australia have seen their sources of international financing dry up as debt investors in the U.S. and Europe shun risk, pushing some companies to the brink of bankruptcy.
Problems at Fannie Mae and Freddie Mac could deepen the crisis. "This is the most dangerous moment," says Andy Xie, an independent economist based in Hong Kong, who believes a U.S. government bailout would likely lead to a further decline in the dollar. That hits directly at the value of massive dollar-based securities held by Asian central banks and institutions.
The most serious damage to Asia would likely come if the Fannie and Freddie crisis exacerbates the U.S. housing downturn and triggers a full-blown recession in one of the region's biggest export markets.
China is already starting to feel the impact of a weaker U.S. economy. So far, China's overall exports have held up reasonably well this year, growing 21.9% in the first half, but exports to the U.S. grew just 8.9% in the six-month period from a year earlier. Many low-cost exporters in China are feeling a serious pinch from weak U.S. demand, the slumping U.S. dollar and rising labor and input costs. India could take a hit if a U.S. recession dries up overseas investment into its developing economy.
The worsening financial crisis is fueling growing skepticism in China of American-style financial-system liberalization. Chinese officials have been unusually vocal this year in expressing concern about America's financial woes and the weak U.S. currency. Premier Wen Jiabao told visiting U.S. Secretary of State Condoleezza Rice last month that China hopes to see the U.S. quickly exit the credit crisis and steady the value of the dollar. At a bilateral economic summit earlier in June, Zhou Xiaochuan, governor of the People's Bank of China, the central bank, said China, which in the past had looked to learn from the U.S.'s management of its economy, is also looking to learn from America's mistakes.
China was already taking a go-slow approach to mortgage securitization even before U.S. woes. Widespread home ownership is only about a decade old in China, and the vast majority of home loans are funded directly by state-owned banks, which mostly keep them on their books instead of selling them off to investors as has been done in the U.S. The first mortgage-backed security was issued in China in 2005, and such repackaging still accounts for a tiny fraction of all home lending. Mortgage securitization in India, too, is still nascent.
Other parts of Asia have been securitizing mortgages successfully. Hong Kong, a part of China with its own economic system and laws, has been issuing mortgage-backed securities since 1997. A selloff in Hong Kong property after the Asian financial crisis cut many home values in half in the period up to 2003 without posing any major problems for the Hong Kong Mortgage Corp., whose debt is rated Aaa by Moody's Investors Service. Mortgages are securitized widely in South Korea and Malaysia, too, for example. HKMC has a joint venture in Malaysia that provides mortgage guarantees in the local market.
While prices of some of these securities have weakened, the HKMC has gone bargain-hunting, buying up nearly $1.5 billion in Korean mortgaged-backed securities in the past seven months, say two people familiar with those transactions. HKMC couldn't be reached for comment about the deals in Korea.
At this point, few experts think woes at Fannie and Freddie will hurt investors in their debts. But if, for some reason, the debts lose their value, the impact would be particularly troublesome on Japanese banks, which so far have largely avoided big losses from the subprime crisis. That is because in Japan, the biggest exposure to U.S. agency debt is with private-sector companies, particularly commercial banks. That is different from China, where agency securities are mostly held by the government in its foreign-currency reserves.
Mitsubishi UFJ Financial Group, Japan's largest bank by market value, held foreign bonds valued at 8.4 trillion yen, or about $80 billion, at the end of March. A large chunk of that amount is made up of agency securities.
Japanese banks have poured money into foreign bonds, including agency securities, in recent years as customer deposits continued to pile up even as demand for loans remained low among Japan's corporate borrowers. U.S. agency bonds have been a favorite investment vehicle for both top banks and regional lenders as they are considered safe, yet offer higher yields than government bonds.
--Niraj Sheth in New Delhi and Alison Tudor-Ackroyd in Tokyo contributed to this article.
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