Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.
    
The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.

"Japan was able to cut its interest rates to zero," said Alex Patelis, Merrills head of international economics.

"It would be very difficult for the US to do this. Foreigners will not
be willing to supply the capital. Nobody knows where the limit lies."

Brian Bethune, chief financial economist at Global Insight, said the US
Treasury had two or three days to put real money behind its rescue plan
for Fannie and Freddie or face a dangerous crisis that could spiral out
of control.
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"This is not the time for policy-makers to underestimate, once again,
the systemic risks to the financial system and the huge damage this
would impose on the economy. Bold, aggressive action is needed, and
needed now," he said.

Mr Bethune said the Treasury would have to inject up $20bn in fresh
capital. This in turn might draw in a further $20bn in private money.
Funds on this scale would be enough to see the two agencies through any
scenario short of a meltdown in the US prime property market.
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He said concerns about "moral hazard" – stoked by hard-line
free-marketeers at the White House and vocal parts of the US media –
were holding up a solution. "We can’t dither. The markets can be
brutal. We have to break the chain of contagion before confidence is
destroyed."

Fannie and Freddie – the worlds two biggest financial institutions –
make up almost half the $12 trillion US mortgage industry. But that
understates their vital importance at this juncture. They are now
serving as lender of last resort to the housing market, providing 80pc
of all new home loans.

Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt – as well as
other US "government-sponsored enterprises" – is now in foreign hands.
The great unknown is whether foreign patience will snap as losses mount
and the dollar slides.

Hiroshi Watanabe, Japans chief regulator, rattled the markets
yesterday when he urged Japanese banks and life insurance companies to
treat US agency debt with caution. The two sets of institutions hold an
estimated $56bn of these bonds. Mitsubishi UFJ holds $3bn. Nippon Life
has $2.5bn.
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But the lions share is held by the central banks of China, Russia and
petro-powers. These countries could all too easily precipitate a run on
the dollar in the current climate and bring the United States to its
knees, should they decide that it is in their strategic interest to do
so.

Mr Patelis said it was unlikely that any would want to trigger a
fire-sale by dumping their holdings on the market. Instead, they will
probably accumulate US and Anglo-Saxon debt at a slower rate. That
alone will be enough to leave deficit countries struggling to plug the
capital gap. "I don’t see how the current situation can continue beyond
six months," he said.

Merrill Lynch said foreign governments had added $241bn of US agency
debt over the past year alone as their foreign reserves exploded,
accounting for a third of total financing for the US current account
deficit. (They now own $985bn in all.) By most estimates, China holds
around $400bn, Russia $150bn and Saudi Arabia and other Gulf states at
least $200bn.
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Global inflation is now intruding with a vengeance as well. Much of
Asia is having to raise rates aggressively, drawing capital away from
North America. This may push up yields on US Treasuries and bonds,
tightening the credit screw at a time when the US is already mired in
slump.

Russias deputy finance minister, Dmitry Pankin, said the collapse in
the share prices of Fannie and Freddie over the past week was
irrelevant because their debt has been effectively guaranteed by the US
government under the rescue package.

"We don’t see a reason to change anything because the rating of the debt of those agencies hasn’t changed," he said.

Foreign policy experts doubt that the picture is so simple. Russia is
likely to use its $530bn reserves as an implicit bargaining chip in
high-stakes diplomacy, perhaps to discourage the US from extending Nato
membership to the Ukraine and Georgia.

Vladimir Putin, now Russias premier, has stated repeatedly that his
country is engaged in a new Cold War with the United States. It is
clear that Moscow would relish any chance to humiliate the United
States, provided the costs of doing so were not too high for Russia
itself.

China is regarded as a more reliable partner, with a greater desire for
global stability. Treasury Secretary Hank Paulson has intimate
relations with the Chinese elite, dating from his days at Goldman Sachs
when he visited the country over 70 times.

Brad Setser, from the US Council on Foreign Relations, said the Chinese
have a stake in upholding Fannie and Freddie, not least to ensure that
their loans are "honoured on time and in full".

David Bloom, currency chief at HSBC, said fears that regional banks
could start toppling after the Fed takeover of IndyMac last week were
now the biggest threat to the dollar.

"We have a pure dollar sell-off," he said. "Its a hating competition:
at the moment the markets hate the dollar more than they hate the euro,
even though Germans ZEW confidence indicator was absolutely atrociou