Bloomberg

A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China’s central bank.

“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”

“Tell me again why that would be such a bad thing?” was a somewhat snarky response in comments on a Calculated Risk post about this. Long term, I agree, but it’s the getting to a sane world financial system that will be just a tad bumpy.

Some of the Calculated Risk commenters think big bad commie China is threatening us. Not really. The Seriously Big Deal here is Fannie and Freddie preferred stock and especially the bonds. Lots of central banks, US municipalities, and pension funds hold the preferred and bonds. Having them go splat to zero would indeed be catastrophic and could easily trigger earthquakes in hidden financial fault lines across the planet. (The common stock is already a goner and probably will go to zero or close to it.)

I find it illuminating that such blunt statements by Yu got released in tightly controlled China. Someone, I think, is sending a message.

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