Foreign nations snap up U.S., Europe bank shares

Rising oil prices are just one force empowering 'sovereign wealth funds' to enter Western markets.

The rise of controversial cash funds controlled by foreign governments has suddenly hit home in a very prominent place: Wall Street.

Nations such as China, Singapore, and the United Arab Emirates are effectively taking multibillion-dollar roles as part-owners of Citigroup, UBS, and this week, Morgan Stanley as well.

To these firms, the moves represent a welcome infusion of cash.

But the moves also call attention to concerns in the US and Europe about how to respond to the rising clout of the so-called "sovereign wealth funds" run by developing nations.

These funds have surged in value, and in ambition, thanks to the rising price of oil and rising exports of goods to the US.

For policymakers, a key worry centers more around the realm of research labs than of banking. Funds run by other governments might operate in a different fashion – perhaps with military interests in mind – than private-sector companies.

Yet some economists also see a risk that overreacting to such concerns could backfire at a time when America needs to have its doors open to foreign investment.

In fact, the larger concern with sovereign funds may be that their rapid growth symbolizes an imbalanced world economy. America has been shipping its dollars overseas to buy foreign goods, and now foreign nations increasingly want to invest them in something with higher returns than Treasury bills.

"It is a direct product of our grossly imbalanced trade relationship," says Scott Paul, who heads the Alliance for American Manufacturing in Washington.

Despite the weakening of the dollar against European currencies this year, he says, "you're going to see another sky-high trade deficit with China."

The more the Chinese containers are unloaded in Seattle or other US ports, the more dollars flow back to China. Greenbacks have also been piling up in oil-producing nations, since their sales are typically denominated in US dollars even when the customer is in Europe or Japan.

The growth of these currency reserves has been stunning.

In a recent report, the McKinsey Global Institute finds that Asian central banks have seen foreign reserve assets grow at a rate of about 20 percent a year in this decade. Oil-nation "petrodollar" assets have been growing at the same rate.

Those assets, when combined, total nearly $7 trillion. That's less than half as much as the global assets of either pension funds or mutual funds. But it's growing at a much faster rate and it's already a large pool of potential cash for government-controlled investment funds.

The sovereign funds target a wide range of investments, generally with the aim of earning a higher return than these nations can reap from the traditional haven: bonds.

Wall Street happens to be the target of the moment, because of turmoil in the banking sector. Banks are eager for infusions of capital, and the sovereign funds see a chance to get an ownership stake at a cheaper price.

On Wednesday, Morgan Stanley announced a $5 billion inflow from the China Investment Corp., which analysts say could amount to a roughly 10 percent Chinese stake in the US investment bank.

That follows a $7.5 billion influx by the Abu Dhabi Investment Authority into Citigroup (the leading US bank by assets), and a nearly $10 billion inflow from Singapore Investment Corp. into the Swiss-based investment bank UBS.

Some analysts noted the irony that the sovereign funds, for all the fear they have inspired, now appear to play a welcome role as rich uncle to banks that need to rebuild their capital pools to cover losses in subprime mortgages.

Joseph Quinlan, a stock strategist at Bank of America, said the acronym SWF might as well stand for "salvaging withering franchises."

Many trade experts say that the risks that sovereign funds pose to national security are manageable, although they are significant enough to warrant careful scrutiny.

"They're motivated primarily … to make a profit," says Edwin Truman, a scholar at the Peterson Institute for International Economics in Washington. "But the concern … is that they might be pushed around to do something" by their governments.

The key solution, he says, is already in place: An executive-branch review process that considers national security implications of foreign investments – whether the investor represents a government or some other overseas entity. The process, tightened this year by Congress, is known as the Committee on Foreign Investment in the United States, or CFIUS.

The review authority works, as long as it is used properly, says William Hawkins of the US Business and Industry Council, a private lobbying group for manufacturers. "They haven't been exercising that authority [enough]" he says.

Under the law signed by President Bush this summer, CFIUS reviews now will involve higher-level officials than before and special consideration will be given not just to technology with military applications, but also to critical US infrastructure. Acquisitions by state-owned companies, including sovereign wealth funds, will also get closer scrutiny.

On Thursday, President Bush weighed in on the latest moves by sovereign funds, responding to a reporter's question. He said he is "fine" with capital coming to Wall Street from overseas. The greater worry, he says, would be if the US became protectionist regarding the flow of money.

Experts say that these funds are here to stay – one facet of the rising power of developing nations. Often, these nations don't share America's strong emphasis on the private ownership in economic affairs.

"The rise of SWFs should be seen as a further sign of a shift in the world economy," said Gerard Lyons, an economist at Standard Chartered, in a November congressional hearing on the issue. "Western countries should seize this as an opportunity to work with emerging economies such as China and Russia and others to find common ground rules and a code of practice."

In some of these nations, the line between government and the private sector can be blurry.

In one case now under CFIUS review, Mr. Hawkins says, the Chinese firm Hauwei Technologies is a key investor behind a deal by Bain Capital to invest in US computer-security technology.

"The line between public and private is very thin" in China, Hawkins says.

Beyond ensuring appropriate reviews of such deals, experts say that broader steps could help curb the American trade deficit that has provided much of the fuel for the sovereign funds.

In the recent congressional hearing, trade-law expert Patrick Mulloy recommended three policies in response to sovereign funds:

•Use energy policies to reduce reliance on foreign oil.

•Work harder to address "mercantilist" trade policies of other nations, including export subsidies and currency manipulation.

•even tighter CFIUS reviews. He warned that even without a controlling stake in a firm, sensitive technology could be transferred to other governments.

Mr. Paul of the manufacturing alliance also calls for closer review of both sovereign investments in general, and the trade practices of China in particular.

"There needs to be a process that provides much more scrutiny for these types of investments," he says.

of 5 stories this month > Get unlimited stories
You've read 5 of 5 free stories

Only $1 for your first month.

Get unlimited Monitor journalism.