Analysts think the risks of possessing the bonds of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) aren't as high as previously thought, regarding issues of asset security. Fannie Mae and Freddie Mac are two major US residential mortgage agencies involving in the investment of Chinese foreign exchange reserves.

Three major risks

Yang Yongguang, a senior analyst with Sealand Securities Corporation, suggests that China is facing three main types of risks concerning Fannie Mae and Freddie Mac's bonds:

1. Cashing – the holder is unable to retrieve the capital plus interest;

2. Interest rate hikes – bonds will depreciate as Federal Reserve raises the interest rate;

3. Currency exchange rate – the risk of assets shrinking as the CNY robustly appreciate against the USD.

The risk in currency exchange is the focus of the market's anxiety. Rumors have surfaced that Fannie Mae and Freddie Mac are on the verge of bankruptcy based on the drastic drop in the two companies' stock prices. However, analysts imply that "a potential bail-out from the US government" is available given that the two companies are "government-sponsored enterprises" (GSE) even though no guarantee has be granted so far.

Decrease of bond liquidity

Analysts point out the decrease of the two companies' bond liquidity is responsible for the widened interest margin and the reluctance of transaction. Therefore, stock exchange agencies are the first to be affected.

"Bonds value will depreciate amidst a widened interest margin," said a market analyst, "unless our State Administration of Foreign Exchange holds the bonds to their expiration date."

"There will even be payoff, however, if we purchase the bonds at the current low prices and have them cashed in due time." China's increased holding of US Treasury Bonds is also due to this consideration. "Any act aiming to stabilize the US financial market will be favorable to China."

Zhang Ming, a research fellow with the Institute of World Economics and Politics of Chinese Academy of Social Sciences, thinks otherwise. Financing the deficit in bailing out Fannie Mae and Freddie Mac, the US government may need to issue additional national debts that have higher proceeds, and this will bring down the price of those bonds already on the market.

In light of this, the foreign exchange reserve of the People's Bank of China (PBC), China's central bank, will face a new round of challenge in terms of asset value, since PBC is the second largest holder of US Treasury Bond.

For more details, please read the full story in Chinese

(http://paper.cs.com.cn/html/2008-07/29/content_17177664.htm)

(China.org.cn by Chen Boyuan, July 29, 2008)