China forex watchdog burnt by WaMu collapse

HONG KONG - 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 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.

(Reuters)