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Wednesday, September 03, 2008


external threats

i spend a lot of time trying to analyze and understand the american domestic economic and financial picture, but that of course is not the entire reality. the overriding lesson of financial crises in the last century is that the world outside matters. and the picture painted of that world is pretty frightening in its own right.

the questionable ability of the GSEs to roll some $220bn in debt this month may belie the sanguine picture some on wall street are selling. a lot of street analysis has focused on the asset and losses-on-assets side of the GSE crisis, but this is the slow-moving aspect of the picture. the GSEs are faced with that problem, but the acute threat to them is on the liability side of their balance sheet. and that is a crisis that can play out not in months or years but hours. foreign central banks have been withdrawing from their debt and MBS auctions. to drive home the point, brad setser points out that something has to change or the GSEs must be nationalized this month. the news has made it to the financial times as china may be instructing state-owned "private" banks to sell FNM/FRE debt.

and the story has a kicker. south korea, in the aftermath of the 1997 asian crisis which devastated their currency and sent their economy into depression, has expended considerable effort building up a forex warchest to defend their currency against future speculative attack. however, as yves smith and cafe americain relay, they have made the mistake of investing a significant portion of those reserves in... yep, agency debt, which is now increasingly illiquid. boomtime capital is fleeing the country, and the government -- faced with a powerful currency slide -- may not be able to muster sufficient liquidity to defend the won. in the event, the final option would be to dump FNM/FRE debt at any price -- spiking agency spreads, killing agency finance and effectively forcing treasury to come in as buyer of last resort to nationalize the GSEs.

one doesn't want to lose sight of events in britain either, where a bursting property bubble even more intense than the american variety has, also via yves smith, crippled banks even more severely than in the united states.

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speculation: interesting that Korea is both hamstrung by its holdings of GSE debt AND a contender for Lehman? Any connection, a la Bear and JPMorgan as midwifed by Bernanke? Shotgun wedding and all that...

Interested in your view


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cc, lehman is too small to make any difference to korea's GSE reserves problem -- even as a bond broker, they can't help themselves much less the government of korea.

what may help korea very much, though, is paulson's plan to start buying GSE debt and MBS with the treasury balance sheet. i would think this would aid korea's liquidity situation tremendously. if it doesn't, the problems are much deeper than anyone dared fear.

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