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How China Profited from the U.S. Bailouts

February 24, 2011

This is just in from Wikileaks and Reuters!

China’s economists viewed certain U.S. financial institutions as too big to fail and so invested in them as the economy tanked with the implied guarantee of full support from the U.S. government. To make matters worse China used its economic power to pressure the U.S. Government to bend financial rules and ensure certain U.S. companies didn’t fail.

The U.S. government does not appear to have offered the Chinese a special setup guaranteeing U.S. banks. Instead, the cables show, American diplomats reassured the Chinese by pointing out that Washington had infused banks’ balance sheets with $700 billion in fresh capital, effectively propping up the banking system.

In June, 2009, the head of China’s powerful sovereign wealth fund met with Geithner and requested that he lean on regulators at the U.S. Federal Reserve to speed up the approval of its $1.2 billion investment in Morgan Stanley, according to the cables, which were provided to Reuters by a third party.

Although the cables do not mention if Geithner took any action, China’s deal to buy Morgan Stanley shares was announced the very next day.

This allowed China (and likely other large investors with insider connections) to make a killing as the market tanked, buying up companies on the cheap with the that they privately knew had the backing of the U.S. government.  I’m surprised I haven’t heard about this in the news more.

Of course, the Bailouts are also why the CEO’s and Hedge-Funds who held stock in major financial institutions didn’t have to take any losses on their portfolio, while the tax payer footed the bill interest free (despite the fact the major Banks were suffering losses that would have brought them to the point of bankruptcy absent government support… talk about shareholder losses).

China holds hundreds of billions of dollars in debt issued by Fannie Mae and Freddie Mac, the housing agencies known as Government Sponsored Entities, or GSEs.

Like many other investors, it purchased agency debt before the crisis with the expectation that Fannie and Freddie were implicitly backed by the U.S. government.

In September 2008, when the Treasury Department took control of the two GSEs, SAFE (China’s foreign currency reserve) officials grew alarmed, the cables show. Suggestions that senior GSE debt holders would have to take a haircut sparked a public outcry in China. The media warned that the government’s currency manager faced monstrous losses similar to those suffered earlier by the nation’s sovereign wealth fund, China Investment Corp. (CIC), after its investments in U.S. financial institutions blew up.

Media outlets had already heavily criticized the government for CIC’s losses — a Financial Times story circulated by outlets such as China Daily speculated that CIC had lost $80 billion of the government’s foreign reserves. In late 2008 Chinese newspapers routinely ran headlines with the words “Fannie Mae” and “Freddie Mac” spelled out in English.

To defuse the situation, the Treasury Department sent Undersecretary for International Affairs David McCormick to Beijing for two days in October 2008. The gesture went over well.

“All of Undersecretary McCormick’s counterparts appeared to appreciate his willingness to come to Beijing in the midst of a financial crisis,” Piccuta wrote in a cable dated October 29, 2008. “Interlocutors stressed that unless leaders’ concerns about the viability of banks and U.S. government-sponsored enterprises (GSEs) are assuaged, lower-level officials will be constrained from taking on greater counter-party risks.”

The cables show McCormick trying to reassure the Chinese. “In each meeting, Undersecretary McCormick emphasized that even though the U.S. government did not explicitly guarantee GSE debt, it effectively did so by committing to inject up to $100 billion of equity in each institution to avoid insolvency and that this contractual commitment would remain for the life of these institutions,” Piccuta wrote.

Analysis

Of course, many Americans are much angrier about the guy next door who is actually loosing his house anyways because he didn’t understand the terms in his mortgage contract. In the end its the little guy who has to pay for CEOs’ and China’s guaranteed not to fail stock market gambles. At this point it appears that the Chinese government is even using its influence to determine U.S. domestic spending policy. The good thing for Tea-Partiers and Conservatives is that China seems to share their concerns about inflation.

Xie Xuren, China’s minister of finance, met with Geithner on June 1 and “expressed concern about the potential for inflation and the long-term sustainability of U.S. budget deficits,” according to a cable detailing Geithner’s visit, dated June 17, 2009.

Of course if the U.S. economy doesn’t fully recover because of constrained government spending due to inflation related budget cuts, the deflationary environment will mean China realizes a huge profit on all the U.S. government bonds it holds. It seems China even went so far as to ask the U.S. government to bend financial rules so that they could  purchase a large sum of shares in Morgan Stanley as soon as they came to market (rather than acquiring them at the legal later date -after they presumably appreciated in value).

At the time of Geithner’s visit, Morgan Stanley was planning a new share issue to raise funds to repay the government for the money it received during the financial crisis.

“Lou asked if it would be possible for the Fed to expedite approval of CIC’s request that this investment be exempted from restrictions on investment by bank holding companies, as the customary two-week process for considering such exemption requests is too long to allow CIC to take advantage of this opportunity,” according to the cable.

There’s no record in the cable of how Geithner responded, but it was only a day later, on June 3, that CIC announced plans to purchase $1.2 billion in Morgan Stanley shares.

I’m not really surprised by this level of complicity and backroom dealing between the U.S. and China. But it does seem that China is really starting to push its economic weight around. This reminds me of an economic headline in Bloomberg that caught my eye a little while ago, when China along with Japan conveniently announced it would purchase a large share of European debt immediately prior to its release on the market.

It seems we may indeed be moving towards State-Capitalism, where big businesses and international interests make preferential deals with each other outside of market-place… while giving bad deals to everyone else.

Click Here: To learn more about China and other major holders of U.S. debt.

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