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China shying from shaky US mortgage market
By Olivia Chung
HONG KONG - While China is eager to invest a portion of its US$1.33 trillion foreign-exchange reserve overseas, it is unlikely to take a chance on buying additional US mortgage-backed securities (MBS) as they are now considered too risky, Chinese economists said.
During a recent trip to Beijing, US Department of Housing and Urban Development (HUD) Secretary Alphonso Jackson tried to sell China on the idea of buying more MBS. Investing in MBS
offers better returns for China than US Treasury bonds, and at the same level of risk, Jackson claimed.
He called it a "win-win" situation in a statement released prior to his Beijing trip. "China has bought some mortgage-backed securities from us, but not in great numbers," Jackson said.
China held $414 billion in US Treasury bonds as of April, according to data compiled by Bloomberg. And according to HUD's website, as of June 2006, China held $107.5 billion in MBS, up from $3 billion in 2003 and $100 million in 2002. Jackson was particularly keen to persuade China's central bank to buy more securities from the Government National Mortgage Association (known colloquially as Ginnie Mae), a mortgage association under HUD. (The figures include securities offered by Ginnie Mae, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp, without providing a breakdown of each agency's holdings.)
"The Chinese economy is benefiting from high-yielding, safe investments in US mortgage-backed securities. Here at home, American homeowners are benefiting from lower interest rates on mortgage loans resulting from greater Chinese demand for these securities," Jackson said.
Jackson pressed his MBS case with People's Bank of China governor Zhou Xiaochuan, Construction Minister Wang Guangtao, and officials of Chinese commercial banks. Without elaborating, Jackson said his department wants to sign a memorandum of understanding with Wang when the latter visits the US next month.
However, it promises to be a tough sell for Jackson. The Chinese government may decline the offer given the current surge in mortgage defaults in the US, Chinese economists said. Moreover, China has invested most of its foreign reserve funds in US-dollar assets and wants to diversify its investment.
To improve macroeconomic stability and reduce upward pressure on the yuan, China is setting up an investment agency called the State Investment Co (SIC) to oversee part of its foreign-exchange-reserve investments. While the SIC has yet to be officially launched, it made its first investment in May by spending $3 billion for a stake in the US private-equity firm the Blackstone Group.
China's State Administration of Foreign Exchange (SAFE), which manages the reserves, does not release figures for the proportion of foreign reserves held, but it is estimated that China holds about 70% of its foreign reserves in dollar assets, including treasury bonds.
Yi Xianrong, a senior economist and finance professor with the Chinese Academy of Social Sciences, a central government think-tank, attributed the previous surge of mortgage-backed securities bought by Chinese companies to inexperience in conducting risk assessments and their miscalculation of the US property market.
"After seeing how the property prices in China kept soaring, these Chinese companies never thought of the US property market as having problems and they bought a lot of mortgage-backed securities, particularly in the past two years," Yi told Asia Times Online. "Apart from underestimating the level of risk, the better returns offered by MBS over US Treasury bonds also made the Chinese investors unable to judge the high risk of the US mortgage market."
He said subprime loans are one reason MBS investments are risky. Subprime loans are made at higher interest rates to people are considered bad or weak credit risks. They generally have interest rates at least 2-3 percentage points higher than prime loans.
Of the approximately $7 trillion worth of US mortgage securities, subprime loans currently account for about 15%. Thirteen percent of US mortgage delinquencies in the last quarter of 2006 were from subprime loans and about 30 mortgage companies have gone under in the past few months, Yi said. "There are significant financial losses," he said.
Yi said some bond ratings agencies that advise investors, including Chinese, also purposely played down the MBS risk. "Some ratings agencies slapped investment-grade ratings on mortgage-backed bonds that they knew they were risky," he charged.
Bond-rating agencies this month finally downgraded about $12 billion worth of subprime US mortgage securities, Yi said.
Economist Shi Weigan echoed Yi's comments. "With a possible burst in the housing bubble in the US, it's not the right choice for Beijing to spend foreign-exchange reserve funds on the US mortgage-backed securities," Shi said. |
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