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U.S. looks to reluctant foreign investors to help fund the housing market

By Howard Schneider
Washington Post Staff Writer
Tuesday, February 16, 2010; A01

As the U.S. housing market boomed in the past decade and fueled a bull market in mortgage investments, Norway's government-owned fund went along for the ride -- and the fall.

After that fund recorded its worst-ever year in 2008, managers cited investments backed by U.S. mortgages as a key culprit and began to cut back.

Now, U.S. officials are looking to foreign government funds again. The Federal Reserve is scheduled at the end of March to halt its purchases of mortgage-backed securities, a move that could drive up the low interest rates that have helped the housing market show new signs of life. The Fed is gambling that private investors will step in to buy the securities, helping to keep rates from spiking. Senior officials in the Obama administration and at the Fed say they are counting in part on foreigners to keep the housing market funded.

But financial analysts and advisers familiar with foreign government funds, known as sovereign wealth funds, predicted that the United States will get limited relief from abroad.

"I don't think it will be enough to fill the hole," said Ajay Rajadhyaksha, head of fixed-income strategy for the United States at Barclays Capital.

Nor is Norway's experience encouraging. Its government's holdings of securities issued by the mortgage financier Fannie Mae declined from a 2007 high of more than $15 billion, at current exchange rates, to just more than $5 billion as of Sept. 30, 2009, according to the fund's public reports. Contracts with external investment mangers were slashed, and the fund's guidelines were refocused toward individual stocks, real estate and other deals that the fund's staff had the expertise to vet.

Sovereign wealth funds are pools of money used by governments to make investments. The largest belong to big exporters such as China and the oil-rich monarchies of the Persian Gulf that accumulate trade surpluses.

These funds often set guidelines for the amount of money they are willing to put into bonds or other fixed-income investments, including mortgage-backed securities. Even if interest rates begin a modest rise, as he expects, Rajadhyaksha said he does not think it will be enough for sovereign wealth funds to direct large amounts of money away from alternatives, particularly U.S. Treasury notes, that are less risky and not associated with the mortgage crisis.

"A lot of sovereign wealth funds have a vested interest in seeing the U.S. stabilize," said R.P. Eddy, whose Ergo consulting firm advises foreign funds on U.S. and global economic issues. "But some wealth fund coming in to save the day? That is not going to happen."

The securities issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac are not debts of the U.S. government but do carry an implicit guarantee that the companies will not default. In December, the government carried that a step further, saying it would not limit the amount of money made available to keep the firms solvent.

Senior U.S. officials said the goal was to reassure buyers of the companies' mortgage securities that they were safe. "That's particularly true for foreign investors," said Eric S. Rosengren, president of the Federal Reserve Bank of Boston.

The Fed's departure from the market for mortgage-backed securities is only one step being taken to wind down the emergency measures put in place by the U.S. government during the financial crisis. But it is one that could have a direct effect on homeowners and potential buyers and on the tentative recovery in the real estate market.

By packaging home mortgages into large bundles that are then sold to investors, Fannie Mae and Freddie Mac generate funds that allow banks and other lenders to provide more loans. Keeping that market liquid during the depths of the global credit crisis was a high priority -- enough so that the Federal Reserve is expected to own $1.25 trillion in mortgage-backed securities by the time the program ends.

If funding evaporates in the absence of federal support, that would mean higher interest rates -- making purchases more difficult for buyers and payments more expensive for those with adjustable-rate loans.

But some financial analysts said U.S. officials consider a healthy housing market so vital to an economic recovery that they would roll out new policies to keep mortgage rates low if sovereign wealth funds and other private investors fail to step in with enough funding.

"We recognize that a deep and liquid home mortgage market is an important U.S. policy priority," said Paul O'Brien, head of fixed-income strategy at the Abu Dhabi Investment Authority. He said U.S. officials would be sure to protect this market.

Like most sovereign wealth funds, the Abu Dhabi Investment Authority publishes only broad statements of strategy and does not disclose individual holdings. Norway's fund is an exception. But even those broad intentions hint at the degree to which sovereign wealth funds may be interested in mortgage-related securities in the United States.

Over the past two years, as the world economy cycled from crisis to an uncertain recovery, some sovereign wealth funds were forced to turn inward -- directed by their governments to provide capital to local companies, as in the case of Russia, or pulled back from troubled investments abroad, as in the case of Dubai.

Others signaled a new set of investment interests: commodity and natural resources companies, thought to be undervalued during the economic downturn, and emerging economies that are thought to hold better long-term growth potential than the developed markets of Europe and North America.

In recent publications and interviews, for example, executives at both the Abu Dhabi Investment Authority and Singapore's Temasek fund pointed to a focus on developing markets.

Asian wealth funds in particular are looking to tap into economic growth in their region as a broad new class of consumers emerges, offering fresh opportunities while consumption spending in the United States and Europe plateaus, said Jan Randolph, head of sovereign risk analysis at the IHS Global Insight consulting firm.

Not only is the United States seen as a slower-growth region, he said, but some funds are looking for non-dollar investments to guard against the currency's possible decline and are still hesitant about the U.S. mortgage industry.

"Put yourself in the position where you do have the capital to invest. A lot of it is heading to emerging markets and into equity," Randolph said. "The bigger uncertainties are still in the West."

Staff writer David Cho contributed to report.

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