They don’t call him the “bond king” for nothing. As Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FNM) shareholders got slaughtered Pimco boss Bill Gross netted a very healthy $1.7 billion from the government’s bailout of the toxic mortgage twins. How did Gross do it? “He loaded up on debt rather than equity,” says Justice Litle. And he did it because he knew Treasury Secretary Hank Paulson wouldn’t screw China, one of the biggest holders of US agency debt…

This from Taipan Daily:

Bill Gross (a.k.a. “the Bond King”) is the manager of the Pimco Total Return fund, a whopping monster of a bond fund with more than $130 billion in assets.

Over the first six months of the year, Gross had moved more than 60% of his fund – close to $80 billion – into mortgage debt. What did Gross know that Miller didn’t? He knew that, come what may, mortgage-backed bond holders would have to be bailed out, no matter what… because of the global politics of who else owns that mortgage debt.

For example, guess who was sitting on a massive $15-20 billion pile of FNM and FRE debt as recently as June?

The Bank of China.

They’ve sold off a good chunk since then, but that’s just one Chinese bank – and just the tip of the iceberg as far as Chinese financial institutions loading the boat.

Last year, according to Reuters, China on the whole had accumulated as much as $376 billion worth of U.S. “agency” debt — meaning the bonds of federal-related outfits like Ginnie Mae, Fannie Mae and Freddie Mac.

The upshot is, Treasury Secretary Paulson was happy to make an example out of equity investors like Miller, who knew they were taking a big risk in pursuit of a big return.

But no way, no how was Paulson about to blow out the holdings of one of America’s top creditors (China).

By some estimates, China has now amassed as much as $1.6 trillion in foreign reserves, with more than two-thirds of that parked in U.S. debt instruments (agency debt, treasury bonds and so on). Burn those guys in a bailout plan? You’ve got to be kidding. Fiscally speaking, that would be like shooting ourselves in the foot with a machine gun.

So Gross had a pretty good lock on the situation. He knew it was sharp to align his interests with China’s. And to further ensure a positive outcome, the Bond King took every opportunity by ranting and raving from his soapbox – a mighty big soap box – about how government should be on the lookout for mortgage holders, and how letting mortgage owners suffer would be a travesty.

When news came out that the Fannie and Freddie debt holders would indeed be kept whole (as China demanded and Gross knew would happen), the value of those debt holdings soared, giving Gross a $1.7 billion pop in the value of his fund.

It was a bailout done right in the sense of protecting the players that mattered… and making an example of the ones who didn’t. (Whether it was right in moral or strategic terms is a whole other kettle of fish.)

Source: The $1.7 Billion Payday: Guess Who Made a Killing on the Bailout?