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Us Faces Global Funding Crisis, Warns Merrill Lynch

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The US Treasury may have just days to act before foreign patience snaps, writes Ambrose Evans-Pritchard

Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.

The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.

"Japan was able to cut its interest rates to zero," said Alex Patelis, Merrill's head of international economics.

"It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies."

Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.

"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," he said.

Mr Bethune said the Treasury would have to inject up $20bn in fresh capital. This in turn might draw in a further $20bn in private money. Funds on this scale would be enough to see the two agencies through any scenario short of a meltdown in the US prime property market.

He said concerns about "moral hazard" - stoked by hard-line free-marketeers at the White House and vocal parts of the US media - were holding up a solution. "We can't dither. The markets can be brutal. We have to break the chain of contagion before confidence is destroyed."

Fannie and Freddie - the world's two biggest financial institutions - make up almost half the $12 trillion US mortgage industry. But that understates their vital importance at this juncture. They are now serving as lender of last resort to the housing market, providing 80pc of all new home loans.

Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt - as well as other US "government-sponsored enterprises" - is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides.

Hiroshi Watanabe, Japan's chief regulator, rattled the markets yesterday when he urged Japanese banks and life insurance companies to treat US agency debt with caution. The two sets of institutions hold an estimated $56bn of these bonds. Mitsubishi UFJ holds $3bn. Nippon Life has $2.5bn.

Is the US about to have it's credit withdrawn??? This should have happened years ago.

Will the US now here the words "the computer says no!"

Just how on earth is the US going to get out of this mess, even a bailout can only buy time before the idiots in the City realise the country is bankrupt and can't pay it's debts.

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So, the US "sold" worthless Agency obligations (of Fannie and Freddy) to China, Russia, and the Gulf States and they financed our mortgage market bubble??? Now that the bubble has collapsed, they are worried that Fannie and Freddie may bug out and will default on their loans/CMO/pre-packaged-loans/whatever???

Well, as interest rates fall, the bond's price rises. Conversely, if the interest rate rises, bond prices fall. The US Fed is locked in an impossible equation that they have put themselves into after years of idiotically low interest rates and letting the USD freefall:

US Dollar <= Interest Rates => Mortage Market => Foreign Holders of Fannie, Freddie paper

As you can see, you cannot balance this equation and make every side happy :)

If the FED raises interest rates to save the dollar from becoming toilet paper, that will surely kill off the mortgage market making Fannie and Freddy go under which will mean they default on those loans to the Chinese, Russians, and Gulfies.

You can figure out other scenarios.

Whichever way you chose, the US loses. Our so called 'central bank' which is really a privately own bank with fiat money, has caused this latest bubble in an effort to defray the effects of the previously collapsed internet bubble when 5 trillion of NASDAQ wealth vanished in 2000-2001. Well, now they have really screwed the country.

I am not even going to mention what this means to the 'wonderful trade situation' with China who buys our T-bills/bonds and sends back cheap broken goods. But who knows, may be the Feds have put down collateral such as all the land West of the Mississippi :)

May we live in interesting times - is a nightmare I am trying to wake up from.

Posted by Non Believer on July 16, 2008 2:51 AM

From the comments underneath.

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