Foreigners push back….

August 20, 2008

How often does the NY Post beat the Journal and the Times to a good financial story? Today they did, noting that Lehman tried to secure $5 billion of rescue capital from South Korea, but failed to do so:

Lehman Brothers’ embattled Chief Executive Dick Fuld nearly struck a deal to raise almost $5 billion from South Korean wealth funds and institutions but the pact disintegrated, according to sources familiar with the matter.

That’s the meat of the article. No word on why talks broke down, what Lehman was offering to sell the Koreans, etc.

Though the article is short on detail, it remains very interesting thematically. Sovereign wealth funds that rode to the rescue in the early part of the credit crunch have suffered some brutal losses as I wrote in Post Infusion Blues (see bottom of this post for a nifty chart). Once bitten, twice shy: it’s likely that the Lehmans, Merrills, Fannies and Freddies of the world—who are in desperate need of MORE rescue capital—are finding that foreigners aren’t willing to write any more checks.

Speaking of Fan and Fred, the WSJ published a front page story today with this crucial paragraph:

[Freddie] had to pay hefty interest rates [in an auction of its debt yesterday]….Five-year notes were priced to yield 4.172%, or 1.13 percentage points above yields on safe Treasury notes, the highest “spread” Freddie has ever paid on such debt.

Also this: in this latest auction, Europeans/Asians bought 41% of Freddie’s debt, which is down from an average of 51% last year.

Among the largest buyers of Fannie and Freddie debt are foreigners recycling the dollars they collect as part of their trade surpluses. This is the ultimate source of many of the dollars flowing into the U.S. mortgage market. We buy foreign goods, foreigners get our dollars in return and then have to invest them somewhere. Many end up invested in so-called “agency” bonds; the agencies (Fan, Fred are the largest) use this cash to fund home loans.

If foreigners stop buying agency debt, the capital available to finance housing will be reduced significantly, and mortgage rates will spike.  Anyone who thinks the fall in housing prices can’t get much worse hasn’t considered what will happen if mortgage rates go to 9-12%. The trend isn’t looking good lately as you can see below………

As the latest Freddie auction shows, foreigners (as well as American buyers of Freddie paper) are demanding higher interest rates. The fact that virtually all mortgages are now funded via Fannie and Freddie in some way means their higher interest rates will be passed on to borrowers (see chart right). This is the inevitable endgame of financing one’s lifestyle with too much debt.

After a borrower has borrowed too much, his lenders realize his credit isn’t as good as it once was. If the borrower wants to keep borrowing, lenders will demand higher interest rates to offset the increased risk that the borrower won’t pay them back.

As has been noted on this blog, time and again, America is going bankrupt, which means we are increasingly dependent on those who would lend us money. This gives enormous power to those who do lend money, primarily autocratic governments. The always erudite Brad Setser noted this in a blog post earlier this week, that the foreign reserves of autocratic governments are growing at a much faster pace than those of liberal democracies. Here are some scary charts for you.

This fact, that autocracies are saving dollars at a high rate, is well known. But its implications are rarely considered. Conventional wisdom still considers ours a “unipolar” world, with one major superpower. And yet, autocratic governments like Russia have gained significant financial strength, which they are using to exercise power. Russia has no intention of leaving Georgia, and Western energy supplies are more vulnerable as a result.

Political and military power is just a derivative of economic power. As long as Americans spend more than they earn, ours will decrease.


Here are a few reasons rescuers aren’t riding to the rescue anymore:

(Scroll to the right to see the how badly these bets were timed…)

For those having trouble viewing the table above, you can also see it here.

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