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Henry Paulson’s new book alleges that Russia attempted to convince China to join it in selling large quantities of Fannie Mae (FNM) and Freddie Mac (FRE) (government supported entity, or GSE) bonds in order to force the U.S. government to prop up the GSEs:

Russian officials had made a top-level approach to the Chinese, suggesting that together they might sell big chunks of their GSE holdings to force the US to use its emergency authorities to prop up these companies,” he said.

. . . .

“The Chinese had declined to go along with the disruptive scheme, but the report was deeply troubling,” he said. A senior Russian official told the Financial Times that he could not comment on the allegation.

Bloomberg has more:

Paulson learned of the “disruptive scheme” while attending the Beijing Summer Olympics, according to his memoir, “On The Brink.”

The Russians made a “top-level approach” to the Chinese “that together they might sell big chunks of their GSE holdings to force the U.S. to use its emergency authorities to prop up these companies,” Paulson said, referring to the acronym for government sponsored entities. The Chinese declined, he said.

Russia’s five-day war with U.S. ally Georgia started on Aug. 8, the same day as the opening ceremonies of the Beijing Games. Prime Minister Vladimir Putin told U.S. President George W. Bush during those ceremonies that “war has started,” according to Dmitry Peskov, Putin’s spokesman.

“The report was deeply troubling — heavy selling could create a sudden loss of confidence in the GSEs and shake the capital markets,” Paulson wrote. “I waited till I was back home and in a secure environment to inform the president.”

Putin spokesman Peskov denies the allegation:

Russia never approached China about dumping U.S. bonds, Peskov said today. “This is not the case,” he said by phone.

Note that Peskov is quoted in Bloomberg as a source of information about Putin telling Bush that war had begun; he is not necessarily a definitive source about this other allegation. Note further that the FT could not get official comment one way or the other.

This occurred about a month before the Feds seized the GSEs, and 5-6 weeks before it all hit the fan in mid-September. Although there were clouds on the horizon in the late-summer of 2008, there was little to suggest the severity of the impending tempest. Thus, the Russians should be congratulated for their perspicacity.

I wonder what information led them to this conclusion, and how they obtained it. (Although, their foresight was not perfect. Even though the Russian market had already begun to show serious cracks post-Mechel and with the onset of the Russo-Georgian War, the official attitude was that Russia was becoming an economic juggernaut that was immune from adverse economic shocks from abroad. Not exactly, as events proved.)

Of course, there is a single source for this allegation–Paulson–and he doesn’t provide any real detail as to how he came to know of this gambit, or what information led him to this conclusion.

That said, it is eminently believable. Combine mercenary motives with the Putinists’ raging complexes and resentments of the U.S., and their desire to knock America down a few pegs, and to that add the “I wish my neighbor’s cow would die” element of the Russian character, and you can easily see this happening.

If it did happen, it says a lot about the Russian M.O. Clearly, Russia had 65.6 billion reasons to be concerned about Fannie and Freddie. Moreover, they were rightly anxious about the financial condition of the GSEs, and the potential for a substantial loss in the value of their investment. But, if Paulson is right, rather than behaving in a constructive and forthright way, Russia instead acted the manipulative gangster, and attempted to play Machiavellian Great Games and score geopolitical points.

Such attitudes should be kept in mind when dreaming about resets, and negotiating arms control agreements, Afghanistan logistics arrangements, and actions against Iran.

Source: Russia's Fannie Mae / Freddie Mac Gambit