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UC Berkeley Press Release

Researchers explore increasing foreign investment in U.S. bonds, mortgage securities

– Unprecedented investment in U.S. securities such as government bonds and mortgage-backed securities by China and other foreign countries reflects a growing globalization of real estate finance and generally benefits all sides - including U.S. home buyers enjoying lower interest rates - say researchers at the University of California, Berkeley's Haas School of Business.

So much for the standard real estate mantra that "local is everything," quipped Dwight Jaffee, professor of real estate, co-chair of the Haas School's Fisher Center for Real Estate and Urban Economics, and coauthor with Fisher Center researcher Ashok Bardhan of the just-released report, "Impact of Global Capital Flows, Foreign Financing and U.S. Interest Rates."

The economists calculate that nearly 45 percent of all U.S. Treasury securities and almost 20 percent of all U.S. agency bonds and mortgage-backed-securities (MBS) were funded by foreign, mainly Asian, investors by the end of 2006, up from foreign investments of less than 20 percent and about 6 percent in those categories in 1994. The 2006 foreign investments reflect a total of almost $3 trillion in U.S. corporate bonds, $2 trillion-plus in U.S. treasury bonds, and well over $1 trillion in agencies and MBS.

According to data compiled by the researchers, in recent years Japan has emerged as the No. 1 foreign holder of traditional U.S. treasuries, while China ranks first among foreign investors in U.S. mortgage-related instruments. They report that Japan and China have steadily invested reserves established from trade surpluses, whereas the United States since 1989 has been facing annual deficits that last year exceeded $800 billion, or over 6 percent of the gross domestic product.

Bardhan noted that in 2006 alone, China ran a $232 billion trade surplus with the United States and made net purchases of $105 billion worth of U.S. securities. It also accounted for more than one-third of all foreign purchases of U.S. Treasury and agency securities in the first two months of this year.

"It may seem farfetched as a story, let alone sound economics, but the truth appears to be that U.S. mortgage borrowers have been a primary beneficiary of China's decision to move a large part of its population from rural agriculture to urban manufacturing through export-driven growth, with the U.S. as a major market," the economists say in their report, which was funded by the Research Institute for Housing America and the Mortgage Bankers Association.

The authors estimate that the extensive Chinese investments, primarily by government entities such as the central bank, have lowered U.S. mortgage rates by at least 50 basis points and maybe even one full percentage point.

"The benefits of international trade happen to have landed on one of the most land-locked asset classes imaginable, namely U.S. housing and mortgage markets," they write. The researchers also report that foreign official investors are focusing on agency securities such as those issued by the Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae), rather than shopping the recently hard-hit sub-prime mortgage field.

Various economic and political tipping points may trigger a shift, the economists say. These include increased tensions between the United States and China around possible tariffs or adjusting the exchange rate between the dollar and the Chinese yuan, domestic changes in the Chinese economy requiring substantial new social expenditures, or a U.S. recession that would raise concerns about the vulnerability of the U.S. dollar. Any of these could affect U.S. interest rates, lower market prices of securities, fuel depreciation of the dollar or feed related financial calamities.

The authors contend that redeployment out of U.S. assets "as opportunities arise" is inevitable, but is unlikely to be dramatic, quick or likely to have a sudden, major impact on the dollar-yuan exchange rates.

"International trade and finance are intrinsically cooperative ventures; you can always say no to an offer to trade," said Jaffee. "So, it's unlikely to end with a bang. Foreign investors and traders are too smart to upset the apple cart."

The researchers' full report is online in PDF format.

The Fisher Center is a nationally-recognized leader in research on real estate, urban economics, public policy research and the California economy.