Chinese Giving Up on Fannie and Freddie?

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"If it is not the end of the world, it is the end of the current international financial system"

Gadzooks! Those were the words of a former member of China's central bank over the consequences of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) failing. Seriously, the end of the world? These guys aren't messing around.

Our debt markets are incredibly dependant on foreign investors lapping up as much paper as we can throw at them. Year to date, foreign investors purchased an average $20 billion of so-called agency debt issued by Fannie, Freddie, and other government-sponsored entities per month. It's how the whole international financial system has operated for years. Since savings rates in the U.S. are at or near zero, we rely on those gracious enough to save for us to finance our ventures.

Without significant interests by foreign investors in U.S. financial markets, the bond market circus we've seen over the past year would be magnitudes worse. Less buying interest ultimately means higher interest rates on everything from your Bank of America (NYSE: BAC) credit card to your mortgage with Washington Mutual (NYSE: WM) or Wells Fargo (NYSE: WFC). Foreigners lend, we spend ... nobody ever told us it was going to end!

Well, the times they are a-changin'. The Financial Times reports that the Bank of China (not to be confused with China's central bank) cut its securities issued or guaranteed by Fannie and Freddie by a quarter -- or $4.6 billion -- since the end of June. From the middle of July to the end of August, international investors sold $14.7 billion worth of agency debt and purchased over $70 billion in U.S. Treasury bonds. These huge moves essentially point to jittery investors fleeing the questionably backed agency debt for more reliable treasury debt that isn't going anywhere.

What does all this mean for financial markets? Fannie and Freddie are implicitly backed by Uncle Sam, so any flight from their securities signals foreign investors are questioning that protection mechanism. In all likelihood, this is unwarranted fear -- there's simply no way the government can let Fannie and Freddie securities go under. Nonetheless, if nobody wants to be the last one holding the bag (whatever they think "the bag" is), some investors might choose to sell now and ask questions later.

For related Foolishness:

• Some Chinese Guy Is Paying Your Mortgage
• Why Fannie and Freddie Were Doomed
• Fannie Mae's Return Policy