Globalization, thy name is Wall Street bailout. There is no better demonstration of the new global financial order than the cavalcade of "sovereign wealth fund" white knights riding to the rescue of the world's name-brand investment banks all winter long. On Tuesday, Citigroup and Merrill Lynch both announced huge additional sales of stock to foreign buyers. Some observers are alarmed, fearing a parade of boogeymen out to do the West harm under cover of their aid drops. But they should take heart -- the new players will be hard-pressed to do more damage than the old.
Here's a partial tally so far:
- Citigroup: $7.5 billion from Abu Dhabi Investment Authority and $6.88 billion from Government Investment Corp. of Singapore.
- Morgan Stanley: $5 billion from China Investment Corp.
- Merrill-Lynch: $5 billion from Singapore's Temasek Holdings, $6.5 from Kuwait Investment Authority, $2 billion from Korean Investment Corp.
- Bear Stearns: $1 billion from China Investment Corp.
- UBS: $10 billion from the Government Investment Corp. of Singapore.
A sovereign wealth fund is defined as an investment fund controlled by a national government. While not exactly new on the world scene, such funds have been proliferating of late, a consequence of the high price of oil and the growing strength of East Asian economies. Sovereign wealth funds are currently believed to control around $2.2 trillion worth of assets, and some predict that number could shoot up to $12 trillion or more in less than a decade. But the numbers hardly tell the whole story. Less than two decades after the collapse of the Soviet Union and the West's gleeful jig dancing on the grave of communism, state capitalism is suddenly threatening the autonomy of the global "free" market. Wall Street's elite banks, longtime freedom fighters for deregulation and scorners of all government intervention in the marketplace, are now begging, cup in hand, for aid from a gallery of regimes that includes some of the most authoritarian and undemocratic governments on the planet.
The spectacle is jangling nerves up and down the political spectrum. On the left, a zeitgeist gut check can be discerned in comments tossed out over the weekend by two of the more prominent voices in the political blogosphere: TalkingPointsMemo's Josh Marshall asked, "Am I right to be unnerved by the fact that as a result of the mortgage crisis big chunks of major U.S.-based financial services companies -- Citibank, Merrill Lynch, etc. -- are being bought up not by foreign owners of capital but, in effect, by foreign governments?" and Atrios observed that while "it isn't necessarily problematic to have foreign governments invest in our major financial institutions," people should "be thinking about all of the potential ramifications. Banks aren't simply widget makers; they have a rather special role in the economy."
Representatives of both the left and right are united on worrying about the national security implications of foreign government ownership of chunks (even if non-controlling) of key financial institutions. They can take some comfort, in the U.S., in the 2007 passage of the Foreign Investment and National Security Act, legislation spawned by the Dubai PortsWorld fiasco aimed at precisely this problem. But for some conservative commentators, the clash of civilizations isn't just about geopolitical control of crucial assets, but raises serious ideological questions that many thought had been decisively settled. Wringing their hands with a flutter bordering on hysterical, they worry that the influx of cash from national governments making decisions for strategic reasons, rather than purely economic, will upset the efficient workings of global markets. In Monday's Financial Times, Jeffrey Garten, a professor of international trade and finance at the Yale School of Management, is distraught.
Indeed the reality may be that the era of free markets unleashed by Margaret Thatcher and reinforced by Ronald Reagan in the 1980s is fading away. In place of deregulation and privatization are government efforts to reassert control over their economies and to use this to enhance their global influence. It is an ill wind that blows...
In the late 18th century, capitalism was replacing feudalism. In the 20th century, freer markets won the day. Now the world is flirting with another big transformation in the philosophy and rules of global commerce. Unlike the changes of the past, this new trajectory does not represent progress.
Perhaps it would be more accurate to say freer markets lost the day. The root of Wall Street's woes leads back directly to their own strategic missteps, greed, speculation-run-amok, and lack of appropriate supervision. The brightest minds in finance had exactly what they wanted, a playground where the monitors were looking the other way, and they blew it. When the China Investment Corp. pumps in $5 billion to Morgan Stanley, we are not witnessing the triumph of state capitalism, but rather, the embarrassing, humiliating failure of Reagan-Thatcher style unregulated capitalism. So now the U.S. buys Chinese toys at Wal-Mart, and China uses the resulting cash to buy American banks. Hey, anything's fair in love and war and free markets.
The magnitude of the disaster, from a free market apologist point of view, can hardly be overestimated. By abjectly failing to compensate or cushion the "losers" from globalization -- whether by boosting safety nets, improving healthcare, or investing significant resources in education and training -- the Bush administration guaranteed a growing groundswell of political opposition to global trade. And by failing to properly oversee financial markets, it provided an opportunity for foreign governments that may not share "American" values to become significant players in the heart of the global financial system. Talk about your legacies! The Bush administration not only may have crippled the Republican Party for a generation, but it also might have broken the free market! Whoops!
In November, the U.S. Senate Committee on Banking, Housing and Urban Affairs held a hearing on sovereign wealth funds. The prepared statements of the panelists who testified as witnesses are available at the Committee's Web site, and they make for interesting reading. Two of the panelists made the case for allowing foreign government investment. Their most compelling argument was that including countries such as China as "stakeholders" in the key cogs of the global financial system makes them less likely to take action that would destabilize the U.S. economy. Although the so-called nuclear option in which China sells off its huge holdings of U.S. Treasuries as part of a trade war or worse was never very likely, such rash action becomes even less so the more China is directly invested in the U.S. The more interconnected we are, the more we're all in this together.
And we should at least consider the possibility that governments acting in their nationalist interest might be more prudent in how they invest their money in global markets, in the long run, than traders looking to make a quick killing on derivatives bets. As David H. McCormick, undersecretary of international affairs at the Treasury Department, observed at the hearing, sovereign wealth funds are not fly-by-night day traders.
Sovereign wealth funds have the potential to promote financial stability. They are, in principle, long term, stable investors that provide significant capital to the system. They are typically not highly leveraged and cannot be forced by capital requirements or investor withdrawals to liquidate positions rapidly. Sovereign wealth funds, as public sector entities, should have an interest in and a responsibility for financial market stability.
If only we could say the same for the government of the United States!
Other panelists took a more nationalist approach, portraying China in particular as a latter-day mercantilist empire, intent on manipulating its currency and using its foreign reserves to succeed at the expense of the United States. All the panelists bemoaned the lack of "transparency" in sovereign wealth funds and called for the establishment of a global "best practices" standard for how they should conduct business. Why can't everybody be more like Norway?
The concrete result of the hearing, so far, appears to be a request by the committee that the Government Accounting Office conduct a review of sovereign wealth funds to determine just how much these "opaque" funds control in cash and where they have invested it.
Now comes the latest rash of infusions. The political heat will only rise. The temptation, especially in an election year, to demonize the outsiders crashing Wall Street's party will be irresistible. But let's take a deep breath before we get too het up about foreign governments influencing the strategic decisions of Citigroup and Merrill Lynch and Morgan Stanley. Could they really manage to wreak more havoc than what the home-grown bumblers in charge of those institutions have already caused?