China shying from shaky US mortgage market


Richard Moore

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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 

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 

"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.

Olivia Chung is a senior Asia Times Online reporter.

(Copyright 2007 Asia Times Online Ltd. All rights reserved.

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