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Foreign Investment Drying Up
By Patrick A. Heller, Market Update
July 22, 2008

The current financial crisis over expected huge losses at Fannie Mae and Freddie Mac, two private companies that hold about half the real estate mortgages in the United States, may be the final event that persuades foreign investors and governments to stop lending to the U.S. government and private companies, and a resulting redirection of investments toward gold.

"Sovereign wealth funds that invested in U.S. banks have lost 30 to 50 percent of their investments in the space of six months, so they're becoming more cautious," said Nouriel Roubini, professor at the New York University Stern School of Business and head of Roubini Global Economics.

Sovereign wealth funds, established by Middle Eastern and Asian governments, control over $3 trillion in assets.

Last week, Kuwait authorities announced its sovereign wealth fund would no longer buy Fannie Mae or Freddie Mac debt. Instead, they will boost investments in stocks, bonds and real estate in China, India and Japan.

Also last week, Merrill Lynch warned that the Fannie Mae and Freddie Mac mortgage debacle could bring on a foreign financing crisis within months. The U.S. depends on Asian, Russian and Middle Eastern investors to fund much of the $700 billion trade deficit. With interest rates so low in the United States, Alex Patellis, the head of Merrill Lynch's international economics said, "Foreigners will not be willing to supply the capital."

Brian Bethune, chief financial economist at Global Insight warned that the U.S. Treasury had little time to put real money behind the rescue plan for Fannie Mae or Freddie Mac. He said, "This is not the time for policy-makers to underestimate, once again, the systemic risks to the financial system and the huge damage this would impose on the economy. Bold, aggressive action is needed, and needed now."

In total, about $1.5 trillion of Fannie Mae, Freddie Mac AAA-rated debt as well as other U.S. debt issued by government-sponsored enterprises is held in foreign hands. How long will these investors continue to absorb more losses before they bail out?

Last week, Hiroshi Watanabe, Japan's chief financial regulator, urged Japanese banks and life insurance companies to treat U.S. agency debt with caution, an extreme statement from a nation famous for comments being quite understated.

Rather than disgorge debt at what may be fire-sale prices, it would be more likely that foreign investors will stop buying new U.S. debt. Simply stopping the purchase of additional debt would be enough bring on a major financial crisis. Patellis said, "I don't see how the current situation can continue beyond six months."

Already, a rising percentage of the capital of sovereign wealth funds is being used to purchase gold. As these funds accumulate more assets, and less of it is used to invest in the United States, I expect the rate of gold purchases by these funds to accelerate, helping push up prices over the next year.


Foreign Investment Drying Up

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