Learn From U.S. to "Save Market"

On September 7th, the U.S. Federal Government announced its takeover of Fannie Mae and Freddie Mac, the two financially distressed housing mortgage giants, to avoid the occurrence of a large-scale financial crisis.

The U.S. Treasury move was widely interpreted as the U.S. government’s act to save the market. Meanwhile, in China there is a view that China’s current stock and housing markets are slumping, full of risk and danger. Though not as precarious as the American subprime mortgage crisis, the Chinese government may wish to take precautions in advance to save the market. However, this view is in fact specious.

The U.S. government rescues the market on two special conditions. First, the U.S. Treasury Department is not simply “saving the market.” Unlike the measures taken in restructuring Chinese state-owned banks such as direct removal of non-performing assets, direct financial injection, etc., the U.S. Treasury not only bought the Fannie Mae and Freddie Mac shares, but also announced management changes. In other words, the U.S. Treasury Department saves “Fannie and Freddie” through market-oriented means, rather than by just putting money in. The reason for doing so is that the slumping real estate market is the result of a lack of housing buyers whose confidence lessen in the face of general economic downturn. However, the market is not static. When it warms up, this market will be profitable. The U.S. Treasury Department, through the purchase of the shares, will gain eventually. This is totally different from China’s one-time grant “rescue” approach.

Second, the United States and China rescue markets through fundamentally different procedures. In July, U.S. Secretary of Treasury Paulson proposed to Congress an “assistance plan” for approval: to extend the credit periods of Fannie Mae and Freddie Mac, including, if necessary, the purchasing of the stocks of this two government-funded enterprises. Paulson’s proposal was met with many doubts. An economist from Wrightson ICAP, Lou Crandall, put forward that the U.S. Treasury Department should buy shares of the two companies. And the economist’s idea was finally implemented, as has been shown.

This process shows that in America, before the final stage of saving the market, the course of action must be discussed in congress and the views of different sectors are to be absorbed. But in China, “rescue” programs are often the result of “Pai naodai”, neither transparent nor convincing.*

Should the United States save the market? The question is: In a so-called free market economy, why does the United States use government intervention to “save the market”? In fact, this is a misunderstanding, because Fannie and Freddie are large-scale enterprises closely related to the U.S. financial system therefore the collapse of any of them will cause volatility within the U.S. and global financial markets. Although the monetary injection requires the U.S. government to invest huge amounts of money, but, as U.S. Secretary of Treasury Paulson puts it, “It would cost a lot more to just let it be.” In other words, the situational cost is too heavy without rescue. In today’s globalized world, the deterioration of the U.S. housing market will not only cause losses to the U.S. economy, but also in the whole world as well.

In addition, the U.S. “political market” is as developed as its commercial market. The U.S. government can choose “not to save the market”, but this means the loss of popular support and the loss of votes. Despite the fact that some people have lost their property and even become penniless, they did not lose their right to vote. So if the government does nothing during the economic downturn, its political credibility will be damaged. Although the American presidential election has not yet started, obviously, the Republicans in the White House does not want to see McCain negatively affected by the issue of Fannie Mae and Freddie Mac.

By the end of June 2008, the Chinese-funded banks owned “Fannie and Freddie” bonds totaling about 24 billion U.S. dollars. It is good news that the U.S. Treasury Department decided to save the two mortgage companies through the proceedings. The Chinese banks’ shares soared yesterday, which also confirmed this point. But the move by the U.S. Treasury Department and its significance to China is more than this: its so-called “rescue” is based on the “market” means, relying on democracy and the rule of law. I am afraid this is more worthy of study by the Chinese government.

(The writer is researcher of Shanghai Financial and Legal Institute )

* Translator’s Note: Pai naodai is a Chinese idiom that literally means “pat the head”, implying often personal, impulsive decision-making without consulting the majority.