VZCZCXRO4713
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #3899 2880044
ZNR UUUUU ZZH
P 140044Z OCT 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 0409
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC ASHDC

UNCLAS BEIJING 003899

SIPDIS
ENSITIVE

FOR EAP/CM PAMELA PARK
TREASURY FR OASIA/WINSHIP

E.O. 12958: N/A
TAGS: ECON EFIN CH
SUBJECT: China's SAFE Cautious about U.S. Lending

Ref: Beijing 03888

THIS CABLE IS SENSITIVE BUT UNCLASSIFIED. NOT FOR
INTERNET DISTRIBUTION.

¶1. (SBU) Summary. State Administration of Foreign
Exchange (SAFE) Deputy Director General Liu Jiahua on
October 9 said his agency remained very concerned about
counterparty risk in repo market lending to U.S.
financial institutions. While SAFE's policy towards U.S.
Government-supported Enterprise (GSE) debt has not
changed and the amount of debt purchased has not
decreased, portfolio managers had shifted toward shorter-
term debt. Liu also said SAFE now was focusing more on
sovereign risk among developed countries, in part due to
concern that the large amount of debt guaranteed by the
U.S. and European governments could impact their fiscal
budgets and their ability to service debt. Finally, Liu
observed that the recent U.S. announcement of another
arms sale to Taiwan made it more difficult for the
Chinese Government to explain its policies supportive of
the U.S. to the Chinese public. End Summary.

¶2. (SBU) SAFE DDG Liu Jiahua told Finatt on October 9
that SAFE is very concerned over the danger involved in
lending U.S. treasuries to U.S. financial institutions in
the repurchase agreement (repo) market, without some kind
of guarantee against counterparty risk. With the
collapse of Lehman Brothers, Liu said, they no longer
believe any institution can be considered low risk. In
response, Finatt emphasized the stability of large,
deposit-taking U.S. banks. He also noted that the U.S.
FDIC's expanded powers include the ability to guarantee
bank liabilities to support the banking system and
address the systemic financial risk that could be caused
by a potential bank failure. Liu remained non-committal
on the possible resumption of lending, but agreed that
SAFE had sufficient confidence in those institutions and
would consider a system whereby the Federal Reserve or
other U.S. government agency would act as a guarantor.

¶3. (SBU) Liu stressed that SAFE's policy towards U.S.
Government-supported Enterprise (GSE) debt - specifically,
Fannie Mae and Freddie Mac -- has not changed, and he
thought the amount of debt purchased has not
decreased. If there has been a shift by the portfolio
managers toward shorter-term debt, he believed it was due
to uncertainty on what might happen to Fannie Mae and
Freddie Mac in the longer-term (beyond five years) future,
particularly if those GSEs eventually are
privatized. Liu agreed that the ideal form would be to
separate existing guaranteed liabilities from any new,
privatized entities. He emphasized that SAFE did not
want to take any actions that would affect the market
and/or undermine confidence in the GSEs.

New Worry: Sovereign Risk
-------------------------

¶4. (SBU) Though Liu again emphasized that SAFE has not
changed its policy, he said they now also are focusing
more on sovereign risk among developed countries. Given
the large amount of debt guaranteed by the United States
and European governments, Liu said there is concern that
this could impact their fiscal budgets and their ability
to service debt. In that regard, Liu said USD
depreciation is also a concern.

Public Opinion a Factor
-----------------------

¶5. (SBU) In conclusion, Liu said SAFE has noted the
actions taken to date by the U.S. government to provide
relief and restore investor confidence; those measures
are very welcome and positive. The SAFE working group on
the crisis would welcome opportunities to exchange views
with their U.S. counterparts. Liu - citing an Internet
discussion forum -- said that as in the United States,
the Chinese leadership must pay close attention to public
opinion in forming policies. In that regard, the recent
announcement that the United States intends to sell
another arms package to Taiwan increases the difficulty
the Chinese Government faces in explaining any supporting
policies to the Chinese public (ref).

PICCUTA