By Philip Newswanger, Inside Business - Hampton Roads, June 4, 2007

Chinese cash is keeping U.S. mortgage rates low.

The Chinese own $107 billion worth of mortgage-backed securities, according to the U.S. Department of Housing and Urban Development.

That’s up from $100 million in 2002.

“The Chinese economy is benefiting from high-yielding, safe investments in U.S. mortgage-backed securities,” said HUD Secretary Alphonso Jackson in an official statement. “Here at home, American homeowners are benefiting from lower interest rates on mortgage loans resulting from greater Chinese demand for these securities.”

Jackson, U.S. Secretary of Treasury Henry Paulson and the White House hosted a delegation of Chinese officials two weeks ago in a second round of talks, pegged the U.S.-China Strategic Economic Dialogue.

U.S. and China sealed deals in financial services and aviation, but China refused to allow its currency, the yuan, to float against the dollar.

The report, which catalogued foreign investment in the U.S. housing market from June 2002 to June 2006, was presented at the talks by Jackson and Robert Couch, president of the Governmental National Mortgage Association, known as Ginnie Mae.

China surpassed Japan, the second largest holder of mortgage-backed securities, with $85.3 billion, followed by Taiwan with $24 billion.

Asian countries hold 58.6 percent of total mortgage-backed securities, according to the report, up from 20 percent in June 2002.

Ginnie Mae securities – basically a pool of debt to be paid with principal and interest on multiple mortgages – are attractive because they are backed by the full faith and credit of the U.S. government, so investors are guaranteed timely payment.

China’s hold on U.S. securities and other U.S. assets may have political, economic and social implications, but more so for China, which is a communist-led country, than for the U.S.

Vinod Agarwal, professor of economics at Old Dominion University, views China’s economic boon positively. China has accumulated $1.2 trillion in foreign exchange reserves. In fact, China buys two-thirds of its oil from Sudan. Last week President Bush imposed economic sanctions on Sudan. Chinese and Russian officials denounced the sanctions. And recently a Chinese state fund bought a $3 billion stake of U.S. private equity firm Blackstone Group LP.

“They have to manage the cash,” Agarwal said. “China will be an economic powerhouse and that will lead to economic and political freedom.”

The World Bank raised its forecast for China’s economic growth this year to 10.4 percent from 9.6 percent.

China has parked its cash in the mortgage-backed securities because the U.S. is a safe investment, said Agarwal, a native of India.

India is going through the same transformation. Agarwal said India in 1991 had no reserves and the International Monetary Fund and the World Bank were squeezing India for payments on loans.

“Now they have billions of foreign reserves,” Agarwal said. “They don’t know what to do with it.”

The Organization for Economic Cooperation and Development recently forecast India’s growth will slow to 8.5 percent in 2007 from 9 percent in the previous year as rising interest rates put the brake on consumer spending.

Jim Flinchum, managing principal of Bay Capitol Advisors in Virginia Beach, said China’s purchase of mortgage-backed securities is a result of globalization and reflects the explosive growth in foreign cash looking for a “warm, safe place,” like the U.S.

“Traditionally, Asian investors have strongly preferred U.S. Treasuries, which have significantly lower yields than mortgage-backed securities,” Flinchum said.

“I suspect many foreign investors confuse the full guarantee of U.S. Treasuries with the implied guarantee of mortgage-backed securities,” Flinchum said. “Or, some may prefer the higher yield of mortgage-backed securities, the security of actually having real collateral, for example, mortgages.”

Flinchum said money pouring into the mortgage markets keeps home mortgage rates lower.

“The risk to mortgage-backed securities is not significantly different than to Treasuries,” he said. “Conceivably, the foreigners could ‘dump’ all their holdings at any point in time but only if they are stupid, which they are not.”

“If they dumped everything, the value of their holdings would drop quickly, but that loss is theirs; in fact, it would be a great buying opportunity for U.S. investors.” IB