China warns the U.S.

Freddie, Fannie Failure Could Be World `Catastrophe,' Yu Says (August 22 – Bloomberg)

Aug. 22 (Bloomberg) -- A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.

"If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''

China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong.

China is sending clear signals that it will consider a breach of obligations by the US on its debt to be, well, catastrophic. "For us, or for them?" one wonders. At any rate, the $376 billion in agency debt held by the Chinese could buy a big swath of U.S. corporate assets.

Luckily, Hank Paulson won approval from Congress to pump unlimited amounts of capital into Fannie and Freddie in an emergency, so I’m sure he could provide as many dollars as the Chinese desire to be sure they get back at least as many dollars as they were expecting. The question becomes, what are those dollars good for, and what will they be worth?

Of course, articles like this next one in the WSJ probably don’t help the Chinese feel any better about the situation…

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