"At that time, SAFE was certainly shocked by the news that the U.S. government decided to take over WaMu "

An interesting aspect to WaMu from Reuters:

"By George Chen, Asia Private Equity Correspondent

HONG KONG (Reuters) - China's foreign exchange watchdog, the State Administration of Foreign Exchange, will cut back on overseas equity buys next year after suffering major losses on the collapse of U.S. lender Washington Mutual, according to sources.

Earlier this year, SAFE, which controls around $2 trillion of China's foreign reserves, agreed to invest up to $2.5 billion in fund of U.S. private equity giant TPG TPG.UL -- its first foray into a foreign private equity fund, people close to the situation told Reuters.

In April, TPG, one of the world's largest private equity firms, led a $7 billion investment in Washington Mutual to help the troubled lender boost its capital.

TPG put money into WaMu through several of its funds, including one SAFE invested in, said the sources who declined to be identified due to the sensitive nature of the deal.

Just five months later, WaMu, the largest U.S. savings and loan firm, was closed by the U.S. government, making it one of the largest U.S. bank failures in history.

Its banking assets were sold to Wall Street bank JPMorgan (JPM.N) for $1.9 billion, wiping out about $1.35 billion that TPG and its institutional investors, known as "Limited Partners" had invested.

"At that time, SAFE was certainly shocked by the news that the U.S. government decided to take over WaMu and there was almost nothing that SAFE could do to save its investment," said one of the sources.

"It's a good lesson for SAFE and you can imagine how unhappy it was, just like every other LP of TPG for the deal," he said.

TPG's losses from the WaMu deal are publicly known but the names and investment contributions of limited partners of private equity firms usually remain under wraps.

It is still unclear how much in total SAFE lost from its bet on TPG and WaMu.

One source said SAFE agreed with TPG's plan to rescue WaMu, contributing at least 10 percent of TPG's initial $2 billion investment in WaMu. Other sources confirmed TPG informed SAFE of its plan to invest in WaMu before it took the action and SAFE supported TPG's plan.

NO MORE QUICK DEAL

SAFE was not the first choice of TPG as a partner to rescue WaMu.

In China, the private equity firm is well known for its landmark investment in Shenzhen Development Bank 000001.SZ in 2004, making it the first foreign investor to own a controlling stake in a Chinese lender.

Sources said TPG initially approached China Investment Corp, lobbying the country's official sovereign wealth fund to become a major limited partner of its new private equity fund.

CIC, which was set up by the Communist government last year to earn higher returns on a $200 billion portfolio of its foreign exchange reserves, declined the offer mainly due to concerns about investment risks and poor prospects of U.S. markets, the sources said.

Instead, TPG's dealmakers contacted SAFE and the foreign exchange regulator agreed on condition that TPG would also jointly invest some of its own money in the WaMu deal, the sources said.

The big losses by SAFE in the WaMu deal through its investment in the TPG fund have drawn attention from top government leaders in Beijing, who have urged both CIC and SAFE to be more cautious on its overseas investments next year.

CIC has already attracted massive criticism at home over its deals in U.S. firms, which have been battered by the credit crisis, with its stakes in private equity house Blackstone Group (BX.N) and Morgan Stanley (MS.N) diving in value.

One of the sources said both CIC and SAFE would focus more on overseas investments in fixed income areas rather than equities deals in 2009."

I guess we'll see more bond buying.

"It kept spreads on “Agency” MBS high even after the US government effectively guaranteed Agency bonds "

Brad Setser about the US Treasuries aspect of the Flight To Safety:

"The central bank flight to safety

Posted on Sunday, December 21st, 2008

By bsetser

Floyd Norris of the New York Times highlights a theme that I have touched on many times: foreign demand for US assets with any hint of credit risk has disappeared ( TRUE ). Foreign demand for US corporate bonds( THIS IS MORE ABOUT US INVESTORS AND THE FLIGHT TO SAFETY ) — a category that includes “private-label” asset-backed securities( WHICH ACCRUED INTEREST BELIEFS TALF WILL HELP ) like repackaged subprime mortgages — fell sharply in 2007 and hasn’t recovered. * And more recently foreign demand for US “Agency” bonds — the debt issued or guaranteed by Freddie Mac, Fannie Mae, Ginnie Mae and the like — has fallen sharply( IMPLICIT VS EXPLICIT GUARANTEES ).

Norris highlights this shift effectively( I POSTED ABOUT THIS POST ). But he didn’t quite go as far as he could have( NONE OF US EVER DO MATE ).

I would add three additional points:

1) Foreign central banks — not private investors — have led the shift out of Agencies toward Treasuries( AN IMPORTANT POINT ). We know this because of the data in the Fed’s custodial accounts, which show a clear shift at the end of July. From the end of 2004 to the mid 2008, central banks were only slowly adding to their holdings of Treasuries while their holdings of Agencies the the New York Fed ballooned from something like $250b at end of 2004 to close to $1 trillion at the end of June 2008. And since mid 2008, central banks have been selling Agencies and buying Treasuries in big way( I'VE WONDERED ABOUT THE TIMING AND HAVE SUGGESTED THAT THIS WAS A HARBINGER OF THE CRISIS ). The following chart plots central banks’ custodial holdings at the Fed against my best guess of central banks true holdings of Treasuries and Agencies. That guess comes from a model that I have been working on with Arpana Pandey of the Council that reattributes purchases through London to the official sector in real time, and thus avoids the jumps associated with the survey revisions.** Think of it was anticipating the outcome of the next couple of surveys of foreign portfolio investment (The survey data consistently revises central bank holdings of Treasuries and Agencies up and the UK’s holdings down).

2) The shift from Agencies to Treasuries continued in November and December. There isn’t any “TIC” for those months, but the New York Fed’s data shows a $43 billion fall in central bank holdings of Agencies in November and another $38 billion fall in the first three weeks of December. Since the end of September( LEHMAN ), central bank holdings of Treasuries are up by over $210b and central bank holdings of Agencies are down by close to $130 billion — as the following chart illustrates.

3) This shift destablized the Agency market( IT HAS TO ). It kept spreads on “Agency” MBS high even after the US government effectively guaranteed Agency bonds ( IMPLICITLY. YET, HE'S STILL CORRECT )— and that kept mortgage rates up( OK ). Agency spreads only came down when the United States Fed indicated it would increase its purchases of Agency bonds( OK ) — effectively substituting a Fed bid for a Chinese bid.

The TIC data suggests that the big sellers of Agencies recently have been Russia and China. Russia I understand. Its reserves are falling, and its main goal is to stabilize its own market. China less so. Its reserves are apparently still rising. And while the Agencies have some risk, they have less risk than they did before the US government stepped in to backstop them( VERY TRUE, BUT, IF THERE WAS A DEFAULT OF ANY TYPE, THE AGENCIES WOULD LIKELY BE HIT FIRST. THINK OF THEM LIKE A TRANCHE ). My best guess is that China’s leadership was surprised to learn that they held something like half a trillion of Agencies in the summer, and they told SAFE to reduce its holdings (and generally cut the risk in SAFE’s portfolio).

Fair enough. No country is obligated to take even a tiny bit of risk with its reserves. But actions have consequences. China’s swing away from Agencies means that it will soon have a close to $1 trillion Treasury portfolio — which is a risk of another sort.***( TREASURY BUBBLE IF THEY START SELLING ) It also raises the question of whether China has been quite as stabilizing a presence in the market as the US Treasury claims. China certainly didn’t have to sell Agencies to raise cash.

Indeed, the Fed has done a lot more to stabilize global markets in the second half of this year than the world’s reserve managers( GOOD POINT ). Since the end of June, the Fed has lent close to $600 billion to foreign central banks that were short on dollars.**** The Fed effectively sold off its Treasury portfolio and took on risk in a downturn( TRUE ). Big reserve managers did rather the opposite: the data suggests that they were reaching for yield when times were hood (pushing down spreads) and then reversed course (pushing up spreads) when the going got tough( VERY TRUE, BUT THAT IS THE FLIGHT TO SAFETY. ).

*Much of that demand wasn’t really coming from foreign investors so much as from offshore vehicles that borrowed dollars short and lent long( THIS IS MORE ABOUT US INVESTORS ).
** My formula for adjusting official holdings requires positive purchases through London. In 2000 and 2001 the US was paying down the stock of Treasuries, so there weren’t net flows through London. as a result, the adjusted data series starts in M7 2002. Having annual survey data also helps.
*** Stay tuned for more on the details of China’s current portfolio — I am putting the final touches on a set of revised estimates.
**** Other reserve assets — the line item that corresponds with fx swaps — have increased from a bit over $100b at the end of June to $682 billion in the last week of data. That is a rather substantial flow.

I've made that point that one way to view this crisis is to see a rising spread between US Treasuries and Agencies as a rising spread between Implicit and Explicit Guarantees. In a crisis, such a small difference means everything. Let's now think of the two levels as Tranches, with US Treasuries being Senior and Agencies being Mezzanine. To the extent that investors see a rising risk of the US Defaulting ( All I mean by this is taking actions that clearly lessen the value of the investments they hold. It actually doesn't matter, at this stage, how that devaluation would occur. That's too far in the future. ), the Spread between US Treasuries and Agencies will continue.

I do, however, see an end to this, if the guarantees are made explicit, and investors see our actions going forward to be dedicated to taking the steps necessary to not see their investments devalued. At that point, higher yields will matter once again, even small differences.

On the home front, we need to attack the problem of Corporate Bonds with Tax Cuts.