[seahorse]

Foreign Buyers Flee Fannie Bill Sale
By John M.
Sellers of corporate debt can take some comfort [1] that their bonds don’t share some of the uncertainty of post-bailout agencies, but what are the implications as the GSEs continue to roll over their paper? In this mostly positive story [2] about today’s record bill sale by Fannie Mae, Bloomberg included an obscure paragraph about foreign participation that should really have been written in letters of fire:

Asian investors bought 12 percent of the latest two-year debt issue, as European investors purchased 8 percent, down from 39 percent and 17 percent in the July sale, according to company data. Central banks bought 27 percent, down from 57 percent. …



So on a proportional basis the Asians reduced their participation by over two-thirds and the central banks by over half. That certainly looks significant, and should make tomorrow’s release of FRBNY’s statistics on central bank net holdings of treasuries and agencies most interesting.


We’ve become sensitive to stories about the level of comfort that Asian governments have in agency debt. Today Taiwan put some mild restrictions [3] on the level of exposure to GSE debt of their insurance industry.

In the meantime, there is also the question of confidence in treasuries themselves. One measure [4] of quality seems to be causing some concern. So it’s not just the yield spread between "riskless" treasuries and agencies which is in play, but the absolute yields of both.

Article

[MrBill]

And then increased their purchases of UST ; - )) They did not flee US debt. Not net/net.

[firestarter]

It's a FEAR purchase, however.

[MrBill]

Yes, a fear that their own currencies will appreciate and make their own exports uncompetitive leading to a slowing domestic economy and job losses in the export sector! ; - ))

[seahorse2]

Mr. Bill,

Let's assume this trend of fleeing the debt of F&F continues and that foreigners continue to buy treasuries instead. Isn't the effect of that trend mean housing in the US markets busts? The idea behind the bailout of F&F was to keep the housing market going, or at least, slow its descent. However, if institutions and countries flee their debt, this would kill the whole idea behind the bailouts wouldn't it? Now, its only one month, but let's assume it becomes a trend. Please share your thoughts on what effect that trend would have on the F&F bailout and the idea it would sustain the US housing market.

[firestarter]

Agreed. But boy when this bubble pops, and it will, it'll be a sight to behold, and equities will swirl down the drain simultaneously with it. As long as the WaMu's, LEH's, AIG's, etc are cratering, treasuries will be strong. Once the dust settles (probably months out), they will be the sell of a lifetime.

[mefistofeles]

And then increased their purchases of UST ; - )) They did not flee US debt. Not net/net.

Its really the same thing at this point.

[MrBill]

Seahorse, I agree. Sorry, I was being naughty! ; - ))

The reason that Paulson had to pull the trigger was that CBs and SWFs were not buying Agency bonds, so that F&F's spread over 'risk free' treasuries was more than 100 bps versus 25 bps before the crisis. At that level (or price of funding) they cannot turn a profit, so they could not a) afford to extend new loans, and b) ensure that their financial position (debt to equity) did not deteriorate further.

But as you suggest, Act II is when by taking on Agency debt by the Treasury results in UST yields rising that increases the cost of funding to the entire US government to both take on new debt and to service existing debt. Should those self-same CBs and SWFs start to shun USTs as well as Agency bonds then the end result is the same. A deterioration in the US' ability to fund itself.

The only way that circle could then square itself is to attract domestic funding to close the US' budget deficits. Keeping in mind that the federal deficit is covered in competition with both state and municiple borrowing needs as well. That net increase in total borrowing (to replace foreign lending) would have to come at the expense of capital invested in the housing market, stock market, corporate bond market, etc. Real yields would have to, and certainly would, rise to attract that funding. That would slow economic growth further and cause asset prices to fall as well.

The virtuous cycle of falling interest rates and low volatility is giving way to a vicious circle of rising rates and increased volatility. Savers and investors whether they are domestic or foreign must be compensated for that extra risk. Otherwise their capital will flow elsewhere. Either into physical assets and/or offshore. So this in the end would naturally constrict F&F's ability to expand their balance sheets, while no private lender has the liquidity or risk appetite at the moment to (re)assume that central role.