What will China do?

Ian Welsh looks east:

China holds a ton of mortgage backed securities. AIG insures many of them. Freddie and Fannie guarantee many of them. Failing to bail those firms out, failing to guarantee that paper, meant that China would be stuck with cents on the dollar. And after taking a loss like that, they might not be willing to keep extending the US what amounts to loans. And if that happens, the dollar crashes, or interest rates have to go through the roof.
And that's the barrel of the gun that Bernanke and Paulson are looking down.