Thursday, December 13, 2007

The Risk of Sovereign Wealth Funds

When someone gives you money, either buys an equity position, lends you money, or just gives it to you out right, you should always look for the string. Few people give you something out of the goodness of their heart. Text in black is my emphasis. From the WSJ:

Abu Dhabi's sovereign-wealth fund invests $7.5 billion in Citigroup, the largest U.S. bank. Singapore's sinks $9.72 billion into UBS, the big Swiss bank. China puts $3 billion into U.S. private-equity giant Blackstone Group.

Good or bad? Short answer: Yes.

It is awkward, to say the least, for the West to complain when Asian and Middle Eastern government-owned investment pools shore up capital-starved banks that are vital to the world economy. It is like running out of gasoline in the middle of nowhere and being picky about who drives by with spare fuel. And the U.S. economy needs about $2 billion every day from foreigners to keep it going. It gets this money by borrowing or by selling off chunks of assets like Citigroup or Bear Stearns.

Even without counting the vast reserves of Asian central banks, sovereign-wealth funds, or SWFs -- an abbreviation once more common to personal ads than news columns -- today have about $3 trillion in assets and are on their way to $12 trillion by some estimates. They are bigger than hedge funds and private-equity firms combined, though those outfits magnify their clout with lots of borrowed money. And they pose at least three risks:

The first worry is backlash. Americans, with some trepidation, accept foreign investment in the U.S. -- especially when it comes in the form of jobs making Toyotas or price-reducing competition for cellphone service from Germany's T-Mobile. But the 2006 explosion over the proposed purchase by Dubai Ports World of operations of several U.S. ports single-handedly raised barriers for foreign direct investment around the world. It is a reminder how much anxiety there is about globalization and how quickly politicians can respond.

The specter of undemocratic governments buying up whole U.S. companies, or stakes large enough to have a big influence, is red meat to xenophobes and protectionists. "For America to address one problem -- the special concerns that arise from government ownership of business -- with another one -- betraying our commitment to open markets -- would only result in more government interference in our own markets," the chairman of the Securities and Exchange Commission, Christopher Cox, warned in a speech earlier this month. No wonder U.S. officials are pleading with SWFs to subscribe to some sort of code of conduct.

The second worry is both economic and political. When Cerberus Capital Management, a private-equity firm, swallows Chrysler, there is one certainty: It's in it for the money. Private-equity firms buy low and sell high; that is what capitalism and markets are all about. One big worry about the SWFs is that they might not be in it just for the money.

"The fundamental question presented by state-owned public companies and sovereign-wealth funds," Mr. Cox said, "does not so much concern the advisability of foreign ownership, but rather of government ownership." (Mr. Cox's concerns extend beyond SWFs. Eight of the 20 largest publicly traded companies in the world are state-controlled, he observed.)
It would be ironic if a long period of privatization of government-owned companies from France to China, which clearly helps make them more efficient and productive, came to an end with cross-border renationalization.

"The logic of the capitalist system," former U.S. Treasury Secretary Lawrence Summers has said, "depends on shareholders causing companies to act so as to maximize the value of their asserts. It is far from obvious that this will over time be the only motivation of governments as shareholders."

Is the government of Russia's Vladimir Putin (with an SWF of $150 billion and growing) really going to act like the managers of Harvard University's endowment? A private Saudi investor with a 5% stake in Citigroup helped oust a chief executive. Can we be sure an oil-producing government with a 5% stake won't seek to influence the bank's willingness to lend to finance alternatives to oil? "What about the day," Mr. Summers asked, "when a country joins some 'coalition of the willing' and asks the U.S. president to support a tax break for a company in which it has invested?"

The third worry is klutziness. When really big investors make really big mistakes, the consequences rarely fall only on the investors.

The world economy is shuddering from the mistake that very large, sophisticated investors and lenders made in buying securities linked to mortgages.

The best, oldest SWFs are at least as shrewd as Citigroup, UBS and Merrill Lynch, and that is scary enough. The new ones, swollen with oil revenues or proceeds of currency-market dealings, are like teenagers with more inherited wealth than they can handle.

They will grow up eventually, but you wouldn't want them gambling with the world economy before they are ready.

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