There’s a bit of Schadenfreude in Asia as the American-style capitalism imposed on the region for years boomerangs on the US economy. Any pleasure found in the US’ comeuppance may be brief.
The latest phase of the global credit crisis — troubles at Fannie Mae and Freddie Mac — is the most dangerous yet and it’s heading Asia’s way.
If Japan, China and other Asian economies skipped the worst of the subprime mess, turmoil in US agency debt is a very different story.
There has been much rejoicing in markets about how the government is riding to the rescue to stem a collapse in confidence. US treasury secretary Henry Paulson has requested the authority to buy unlimited stakes in Fannie Mae and Freddie Mac and to lend to them.
No one should be surprised that Paulson and Federal Reserve chairman Ben Bernanke will do their part to take the “sponsored” out of “government-sponsored enterprise”, or GSE. GSEs are the backbone of the housing market that sustains the biggest economy. They also are global institutions increasingly on the front lines of US foreign policy.
Foreign central banks hold almost $1 trillion (Rs43.2 trillion) of agency debt on top of the trillions of dollars of treasury notes and bonds warehoused around the globe.
The White House would rather avoid late-night telephone calls from jittery finance officials in Beijing, Dubai, Moscow, Tokyo and elsewhere.
Fannie Mae and Freddie Mac are believed to be too big to fail. They also, as predicted by former treasury secretary Lawrence Summers, have become too geopolitical to fail.
Too big to save?
The even bigger question preoccupying investors is whether the global credit markets are too big to save.
The sight of the US engaging in the kind of financial socialism for which it has long chastised Asia is spooking markets. It’s a reminder that those betting that the credit crisis is over will be disappointed. It also sets a precedent that will have investors expecting the US government to bail out other financial institutions.
Critics of the US’ latest rescue effort were quick to compare it with the Fed’s salvage of Bear Stearns and Companies. Bear Stearns’ failure is one thing, yet few institutions matter more to the US economy than Fannie Mae and Freddie Mac.
“The failure of these agencies would pose systemic risk not just to the US financial system but the global system,” says Marc Chandler, global head of currency strategy at Brown Brothers Harriman and Co in New York.
It’s a judgement call. Either things are allowed to become so grave that they topple the financial system, or policymakers do whatever it takes to restore calm. It’s about keeping the US dependent on foreign capital to fund its excesses, and more public money will probably be used.
“It doesn’t mean that individual institutions still do not have challenges or that there will not be more bank failures, or that the financial crisis is over,” Chandler says. “It simply means that the government has the wherewithal and will to avoid a systemic meltdown.”
Japan, China and the rest of Asia certainly hope so. In the meantime, Asian central banks stand to benefit from an effort that investor Jim Rogers, chairman of Singapore-based Rogers Holdings, calls an “unmitigated disaster”.
Government help is likely to reduce the risk premium on agency debt over treasury securities of similar maturity. Investors such as Bill Gross, who manages the $129 billion Newport Beach, California-based Pimco Total Return Fund, say regulatory steps could make outstanding Fannie Mae and Freddie Mac debt look more like treasury securities in terms of credit quality and yields. Talk about a nice capital gain.
The indirect effects of the US credit mess are amassing on Asia’s doorstep. Further weakness in the US will undermine Asian growth and continue driving the region’s equity values lower. Asian central banks may also have growing losses as the US dollar slides.
For example, Japan’s three biggest banks had 4.7 trillion yen ($45 billion) in debt securities issued by US mortgage companies Fannie Mae and Freddie Mac as of 31 March, Nikkei English News reported on Tuesday.
While hardly a crisis, such figures are a reminder that turmoil in US agency debt is a growing problem for Asia. That’s the short-term damage. A couple of longer-term questions also are worth exploring.
One is what recent chaos means for American-style capitalism in Asia. Scandals at Enron Corp. and WorldCom Inc. this decade made the US look hypocritical in its calls for Asia to become more transparent. More recent events show the extent to which Enronitis came to Wall Street.
Another question is whether the drive to increase securitization will slow. Since Asia’s 1997 crisis, policymakers have worked to create more sophisticated markets for mortgage- and asset-backed debt. Now, with the US bond business in shambles, Asia may need to find a new model.
Amid so many imponderables, one thing is clear: 2008 might be a more punishing year in Asia than previously thought.
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