Foreign funds helping U.S. in crisis

GENEVA

Help for troubled American financial companies came earlier this year from an unlikely source - the same sovereign wealth funds (SWFs) that many have decried as a threat to U.S. economic independence. Recently, however, the funding has dried up.

The credit crisis that prompted lawmakers and the Bush administration to take up an unprecedented $700 billion rescue package last week could have been much worse if not for the huge injections of capital into U.S. financial companies from the foreign-owned wealth funds at the end of last year and earlier this year, according to financiers and economists.

“Thus far, the role of SWFs in the context of the past year’s turmoil in advanced-economy financial markets has been notably positive,” said John Lipsky, first deputy managing director of the International Monetary Fund, in a recent speech.

But the funds’ huge cash infusions into fast-sinking companies like Citigroup and Morgan Stanley early in the financial crisis proved to be bad investments for most. By summer, big losses on U.S. financial investments by the funds had caused the spigot of cash from overseas to dry up.

Analysts say the pullback in funding from the sovereign goliaths as well as other potential overseas investors is one reason banks are so hard up for cash and in so much trouble today.

“Show us a sovereign wealth fund that’s made money,” said Rob Cox, analyst with Breakingviews.com. “With one or two exceptions - such as Singapore’s injections of money into Merrill Lynch - the investments made by these quasi-government funds over the past year are substantially underwater.”

Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations in New York, said the funds have been hoarding cash in recent months and are reluctant to plow more money into investments that have gone sour.

“The easy deals are no longer available” for U.S. banks, said Mr. Setser, a former staff economist at the Treasury Department. The funds are likely to demand more control over institutions before they invest more and have been stung by criticism at home for making poor investment decisions, he said.

It is also not clear, Mr. Setser said, what happens if a company in which SWFs have a major stake goes under. “Who bails it out? The U.S. taxpayer?”

While the sovereign funds look more like helpful dupes than menacing Trojan horses in the world of finance today, perceptions of the investment funds, which are held and managed by governments around the world, have not always been so positive.

Concern crescendoed earlier this year when the boom in oil and other commodities produced rapid growth in the amount of money controlled by the funds, which has mushroomed from $500 billion in 1990 to an estimated $5 trillion today and is projected to exceed $11 trillion by 2013.

“Not only is the volume of SWFs about nine times larger than that of private equity funds, they are also growing more rapidly due largely to fast-increasing trade surpluses and foreign exchange reserves,” said the U.N. World Investment Report for 2008.

The report said that there are about 70 such funds in 44 countries. The vast majority of holdings are in China, Norway, Russia, Saudi Arabia, the United Arab Emirates (UAE), Kuwait, and Singapore - not coincidentally mostly major oil producers.

The Abu Dhabi Investment Authority of the UAE has between $500 billion and $875 billion under management, the U.N. said. Norway’s pension Fund Global is worth $373 billion - a third of it invested in U.S. entities - and China’s state administration of foreign exchange runs nearly $312 billion, much of it in U.S. Treasury bills and bonds.

“In an era where financial assets under management, not the size of a standing army, increasingly dictate the influence of nations, massive pools of capital controlled by foreign governments have been labeled a clear and present danger by both the United States and European Union,” said Joseph Quinlan, chief market strategist at Bank of America.

But he added that the increasing power of the funds outside China was mostly the result of the spectacular rise in oil and other commodities, which filled the coffers of the petro-states but has been rapidly reversing since July.

“Energy policies that effectively reduce world oil demand, oil prices and oil profits would go a long way in diluting the financial clout of the world’s major oil producers and their sovereign funds,” Mr. Quinlan said. “Reduce the number of petro-dollars in circulation, and you reduce the influence of SWFs.”

Even as their sources of revenue and earnings rapidly dwindle, perceptions of the funds have been improving in light of the constructive role they played in stabilizing the U.S. financial system earlier this year.

Indeed, the crisis could have been far worse had SWFs not plowed huge sums into troubled financial services companies in the past year.

For example, China Investment Co. has invested $5 billion in Morgan Stanley; Abu Dhabi’s Investment Authority took a $7.5 billion stake in Citicorp; Kuwait’s Investment Authority bought a $5.4 billion equity share in Merrill Lynch; and Government of Singapore Corp. (GIC) a $9.8 billion stake in the Swiss bank UBS.

Anne Miroux, chief of investment analysis at the Geneva-based U.N. Conference on Trade and Development, and lead author of the U.N. report, said that SWFs still have “huge potential” and that they are now going beyond traditional areas such as services.

Robert Vastine, president of the U.S. Coalition of Service Industries, an industry umbrella group, said the funds can and should do more.

“All this wealth has to be recycled, or Wall Street is not going to get help,” he said in a telephone interview. “These funds have been extremely helpful. The key thing is we need to recapture these funds to generate stability and growth in our economy.”

The Treasury Department, with an eye on financing the nation’s huge national debt and current account deficits, has been the chief cheerleader encouraging investments by sovereign funds in U.S. companies and markets.

“Maintaining open investment policies is more important today than ever,” in light of today’s financial crisis, said Robert Saliterman, a Treasury spokesman.

Despite their recent stabilizing role in shoring up the capital base of major banks heavily impacted by the mortgage crisis, there is still suspicion of the funds in many countries - especially funds from emerging nations, the U.N. report said.

Concerns include the possibility that SWFs could gain control of strategic industries or that such funds might invest in companies that were privatized in recent years and that improvements in efficiency might be rolled back.

“Investments by SWFs can raise concerns as to whether their objectives are commercial or driven by political, defense or foreign policy considerations,” writes Angel Gurria, secretary–general of the Organization for Economic Cooperation and Development in a June letter to the organization’s 30 members.

There is also skepticism in some quarters about investments from funds in countries that “lack a free market or respect for human rights and sound environmental standards,” the report said.

Another major criticism, according to the U.N., is that the funds, with the exception of Norway and Canada, lack transparency.

“Despite their potentially strong impact on the market, SWFs have little accountability to regulators, shareholders or voters, and there are limited data on their investment strategies, portfolio composition and the average annual returns on assets,” the report said.

Richard Samans, managing director at the World Economic Forum, urged the funds to “take on good governance and transparency standards” to help alleviate such concerns.

“Higher governance standards are the prerequisite for SWFs to become a permanent force in financial services,” said a report by the management consulting firm Oliver Wyman.

The U.N. report said clear procedures and government guidelines “identifying which industries are regarded as strategically important, should be established to make the investment environment more predictable.”

Trying to alleviate such fears, the IMF and several SWFs have crafted a preliminary agreement on a set of voluntary “generally accepted principles and practices.” The guidelines are slated to be presented this month to an IMF policy-setting committee and to be reviewed by the agency’s 185 member countries.

The best practice norms aim to ensure greater transparency, accountability and predictability in the operation of the funds and to prevent governments from resorting to protectionist barriers.

“The proposed guidelines are not sufficient, but it’s a first step,” said Ms. Miroux, the lead author of the U.N. report. “The optimal situation is to have mandatory guidelines.”

The Norwegian Fund is regarded as the “gold standard” for good governance, accountability and transparency standards. It publishes reports on performance, risks and costs on a quarterly basis, and an annual listing of all investments. It also reports regularly on investment strategy and ethical guidelines.

• Patrice Hill reported from Washington.

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