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.