Fannie/Freddie & China

A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.

"If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. "If it is not the end of the world, it is the end of the current international financial system.''

Freddie and Fannie shares touched 20-year lows yesterday on speculation that a government bailout will leave the stocks worthless. Treasury Secretary Henry Paulson won approval from the U.S. Congress last month to pump unlimited amounts of capital into the companies in an emergency.

China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong. The Chinese government probably holds the bulk of that amount, according to McCormack.

Industrial & Commercial Bank of China yesterday reported a $2.7 billion holding. Bank of China Ltd. may have $20 billion, according to CLSA Ltd., the Hong Kong-based investment banking arm of France's Credit Agricole SA. CLSA puts the exposure of the six biggest Chinese banks at $30 billion.

'Beyond Imagination'

"The seriousness of such failures could be beyond the stretch of people's imagination,'' said Yu, a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences in Beijing. He didn't explain why he held that view.

China's government hasn't commented on Fannie and Freddie.

Yu is "influential'' among government officials and investors and has discussed economic issues with Premier Wen Jiabao this year, said Shen Minggao, a former Citigroup Inc. economist in Beijing, now an economist at business magazine Caijing.

Investor confidence in Fannie and Freddie has dwindled on speculation that government intervention is inevitable. Washington-based Fannie has fallen 88 percent this year, while Freddie of McLean, Virginia, has slumped 91 percent.

Paulson got the power to make purchases of the two companies' debt or equity in legislation enacted July 30 that was aimed at shoring up confidence in the businesses. He has said the Treasury doesn't expect to use that authority.

The two companies combined account for more than half of the $12 trillion U.S. mortgage market.

Source - Bloomberg