Foreigners’ love for American assetsat risk after home mortgage scare

And as Greg Peters, head of US credit research at Morgan Stanley, puts it, foreigners have become “big” purchasers of these products in recent years. In fact, banks doubled the amount of CDOs outstanding in the past two years to $2.6 trillion, including a record $769 billion sold last year, according to JPMorgan Chase & Co. These figures include funded and unfunded issuance. “Securitised consumer debt like ABS and MBS have been the Gatorade quenching the global thirst for yield,” added Pomboy, referring to asset-backed and mortgage-backed securities. Figuring how much juice foreigners put to work in these CDOs and collateralised loan obligations or other exotic derivatives is difficult to pin down, said Peters and Pomboy.

US Treasury data show that in 2006 81 per cent of net foreign inflows were in so-called agency debt sold by Fannie Mae and Freddie Mac and US corporate bonds, which include ABS and MBS. These are securities that are packaged in CDOs.

Those staggering inflows into the credit markets could slow, however. Lehman Brothers estimates that the total market for subprime-related CDOs has lost about $18 billion to $23 billion of its value owing to the recent widening in subprime subordinates and ABS CDOs. “We think investors and speculators are getting out of existing positions to preserve capital until the dust settles,” Marc Chandler, global head of currency at Brown Brothers Harriman, wrote in a report. “While we aren’t suggesting we’re clearly at the end of this move, we do think the corrections, while large for a few weeks, are relatively small given the magnitude of the (big price) moves over the past year or so.”

Even so, investors and strategists remain worried over a risk of reallocation of assets from the US market. Were that to happen, it would greatly complicate the task of financing America’s current-account deficit, which at $856.7 billion in 2006 was a record 6.5 per cent of gross domestic product. That’s up from 1.7 per cent of GDP a decade ago.

In dollar terms, that means the US needs to attract $3 billion to $4 billion per day to balance its payments. If it fails to, the dollar will weaken over time, potentially driving up inflation and interest rates. For now, those needs have been largely met by foreign purchases of US securities. In 2006, net foreign acquisition of long-term securities totaled $730.4 billion, 4.5 per cent higher than the previous year. Meanwhile, the broadest gauge, monthly net Treasury International Capital inflows, totaled $827.9 billion, up 24 per cent from the previous year.

Trouble is brewing in a prime area of the credit markets: Lower-quality, lower-tier quality US assets, said Michael Cosgrove, proprietor of The Econoclast, a monthly analysis of the economy and financial markets.