Last Thursday several members of Congress, representatives from the Securities and Exchange Commission, Department of Treasury, and several NGOs testified before the US-China Economic Security and Review Commission, a bipartisan congressional advisory panel. The full day hearing intended to examine the national security implications of investments made by sovereign wealth funds in the US. Unfortunately, it missed achieving this objective by a long shot. The testimony by several of the panelists was very one-sided. Fear mongering, conspiracy theories, and downright xenophobia were the major themes that won the day.

The panelists’ prepared statements can be accessed here: (US-China Economic Security and Review Commission)

Some of the highlights:

Linda Thomsen, director of the SEC’s Division of Enforcement suggested that SWFs pose an insider trading risk (Securities and Exchange Commission):

…sovereign wealth funds, like hedge funds, have, by virtue of their substantial assets, substantial power in our financial markets. However, in addition to this financial power, sovereign wealth funds, unlike hedge funds, have power derived from being governmental entities, which may give them access to government officials and information that is not available to other investors. There is the potential for these powerful market participants to obtain material non-public information, either by virtue of their financial and governmental powers or by use of those powers, to engage in illegal insider trading using that information.

I understand the issues that the SEC is concerned with. It’s their job to be vigilant about insider trading risks. But it’s important to point out that any investor can legally have as much access as they want to government officials by simply hiring a lobbyist. The lobbying system in the US puts the onus on each individual party (government official, lobbyist, client) to not do anything illegal. If we want to be objective, then SWFs and their governments should be held to the same standards as everyone else. Also, it’s not fair to say that SWFs, who to my knowledge have not been involved in any investment scandals, are guilty until proven innocent while hedge funds, mutual funds, investment banks, ratings agencies, and lobbyists are given the benefit of the doubt even after being mired in scandal after scandal. To suggest otherwise seems needlessly conspiratorial.

Senator Jim Webb argued that that passive, minority stakes taken in US corporations by SWFs posed national security risks (U.S.-China Economic and Security Review Commission: Webb testimony):

All proposed foreign investments that have national security implications are potentially subject to review by the Committee on Foreign Investment in the United States. I have been particularly concerned regarding passive investments that may nonetheless provide foreign governments and state-owned corporations with control over sensitive national security information.

 

Holding a small minority of shares or not taking a board seat does not provide a guarantee that there will be no influence or control. For example, Saudi Prince Walid Bin Talal, who holds a 3.9 percent stake in Citibank, was closely consulted in the ouster of Chuck Prince from Citibank as its CEO. Prince Bin Talal does not sit on the board. You do not need a seat on the board, however, to have a seat at the table.

 

Prince Bin Talal has invested his money, not his government’s, and he is held up as a responsible and conscientious investor. The Prince’s role in another Prince’s ouster, however, speaks volumes to those who suggest that you need to be on the board to exert influence.

I don’t think the comparison Webb is making here is particularly relevant. Prince al-Walid is a private investor, so Webb is not comparing apples to apples. Further al-Walid has had a long relationship with Citigroup and most of the senior managers there. Comparing al-Walid to a SWF doesn’t make any sense, but if Webb wanted to be less transparent he could have examined the relationship between al-Walid and the rest of his portfolio holdings, which include substantial minority stakes in dozens of US companies. If all Webb was trying to do was say al-Walid is a foreigner, foreigners run SWFs, so all foreigners will exert influence, then mission accomplished. Of all people, Jim Webb should know better than to use this card.

The Treasury Department has thus far been the voice of reason in the debate over SWFs and played that role again at the hearing (Forbes):

Robert Dohner, deputy assistant Treasury secretary for Asia, told the panel. “There is a risk that the rise of sovereign wealth funds could provoke a new wave of investment protectionism, which would be very harmful to the global economy,” Dohner said. “Protectionist sentiment could be partially based on a lack of information and understanding of sovereign wealth funds, in part due to a general lack of transparency and clear communication on the part of the funds themselves.”

Forbes goes on to make some of the most important points that were inconspicuously absent from the debate at the hearing last Thursday:

(Sovereign wealth funds) see themselves as passive, long-term investors, driven solely by the need to make a good return on their country’s surplus cash.

 

That mostly is their track record, but their Achilles’ heel is their perceived lack of transparency and a persistent concern that they will be motivated by more than just market considerations, which provides ammunition for the conspiracy theorists among their critics and feeds the forces of protectionism stirring in this U.S. presidential election year.

 

At Davos, Bader al-Saad, managing director of the Kuwait Investment Agency, the oldest sovereign wealth fund, which has had a stake in Daimler since 1969 and BP since 1986, politely but pointedly noted, America’s own hedge funds and bond-rating agencies are perhaps equally deserving of such a code.

 

But logic has little to do with this debate.

Concerns over China, Russia SWFs

At a recent finance conference in Brussels, Citigroup chairman Win Bischoff had a very interesting exchange with a German EU parliamentarian (Martketwatch):

“It is the China and Russia syndrome of sovereign wealth funds that is most concerning,” Bischoff told a finance conference in Brussels.

 

China and Russia are the main concern in the debate over whether to regulate state-backed investments, German member of the European parliament Wolf Klinz said. He said German companies are worried that China will steal its intellectual property and fear that Russian President Vladimir Putin wants to use investments “as a political instrument.”

 

“Yes, that’s a very good point,” Bischoff said, nodding at Klinz’s remarks.

Bischoff’s comments are particularly interesting because his firm has recently had several SWF investments approved by the Committee on Foreign Investment in the United States (CFIUS). I would imagine that he is familiar with what the US government’s main concerns have been with SWF investments.

Qatar likely to buy 5% stake in Credit Suisse worth $3 billion

The deal hasn’t been finalized and the stake could be slightly higher or lower. The interesting part of this deal is that Credit Suisse is not publicly recognized as having large subprime related losses, like all the other banks that recently received SWF capital infusions (Marketwatch):

Other than a $1.9 billion writedown related to the sub-prime crisis announced in November, the bank has so far emerged comparatively unscathed from the credit crunch. Sovereign wealth funds from Abu Dhabi, China, Dubai, Singapore and Kuwait have snapped up large stakes in banks such as Citigroup, Merrill Lynch, Morgan Stanley and UBS as they wilted under the weight of huge losses related to the implosion of the U.S. sub-prime mortgage industry.

See more on what the Qatar Invesmtent Authority has planned for the future in this interview chief executive Hamid Al-Thani gave to CNBC at the World Economic Forum last week (Dealbook).

India looking into creating a SWF

Indian government officials have SWF envy (The Economic Times):

While Sovereign Wealth Funds (SWF) owned by big Asian economies invest in assets the world over, Indian policymakers too are looking at whether the country needs to float such a fund. The finance ministry is planning to set up a committee to examine the pros and cons of an Indian sovereign wealth fund.

I’m not sure how much fiscal sense a SWF makes for India. The country is far less developed (infrastructure, education, basic health care, etc) than China and other export-oriented countries with SWFs, doesn’t have an abundance of natural resources, and is a democracy which means the government would likely be held accountable for the fund’s performance. How would the Indian government react to the public backlash from an investment gone bad a la the China Investment Corp/Blackstone deal?

More than a third of India’s population lives in poverty, while in China the percentage of the population living below the poverty line has fallen into the single digits; in absolute terms this is a difference of several hundred million people. How would the Indian government react to hundreds of millions taking to the streets and protesting a government that, from their point of view, is neglecting their dire condition to bailout a foreign investment bank? I just can’t see how there wouldn’t be an immediate change of policy if this type of situation arose in any democratic country, let alone poverty stricken India.

GCC dollar peg, inflation update

Qatar is considering following in Kuwait’s footsteps and dropping the dollar peg (Financial Times):

Qatar is reviewing its currency policy and could revalue or drop the dollar peg as the booming Gulf state struggles to tame inflation while the US reduces interest rates to head off a recession. Qatari officials on Wednesday said the gas-rich emir­ate was considering revaluing its currency or linking it to a trade-weighted basket of currencies as well as other policy proposals aimed at cooling rampant inflation of up to 15 per cent.

Inflation reeking havok on GCC businesses (Arabian Business):

More than half of Gulf businesses have been badly hit by rising inflation, with costs increasing faster than they can be passed on to customers, an ArabianBusiness.com survey has revealed. With inflation rising across the GCC, and predicted to hit a 20-year high of 12% in the UAE this year, 62.5% of respondents to the poll said the price of goods was rising too fast to be passed on.

US backlash to recent investments by sovereign wealth funds

Citigroup and Merrill Lynch are viewed more negatively by the American public on the heels of investments each firm accepted from SWFs (Financial Times):

Citigroup and Merrill Lynch’s standing among US citizens has plummeted as a result of multi-billion dollar capital injections by sovereign wealth funds, according to new research that highlights simmering public opposition to investments by foreign governments.

 

Over half of the 1,000 people polled by the market research group Strategy One said they “trusted Citigroup less” after its recent decision to tap Middle Eastern and Asian sovereign funds to ease its financial constraints.

 

In Merrill’s case, 45 per cent of the respondents said their trust in the bank had fallen since hearing of investments from foreign state funds, according to the research to be published on Tuesday.

The poll draws attention to the rising protectionist sentiment among the American public, which is in part being stoked by politicians like Hillary Clinton:

The new research – carried out early this month between the two waves of foreign investments in Citigroup and Merrill – also points to an underlying current of protectionism within the US public, which could be exacerbated by the rising threat of a recession.

 

“The Citigroup figure is staggering,” said Laurence Evans, president of Strategy One, which is owned by the public relations group Edelman.

 

“There is a xenophobic element to it. The biggest concern is uncertainty: people don’t know how much influence sovereign wealth funds will have.”

Gulf response to US rate cut

Gulf central banks, whose currencies are pegged to the US dollar, have decided to follow the US Federal Reserve’s 75 basis point interest rate cut with reductions of their own (Arabian Business News):

“The Gulf will have to match the Fed cut,” said Marios Maratheftis, regional head of research at Standard Chartered Bank. “This is going to create even more liquidity in the market which means more inflationary pressures.” Inflation in four of the six Gulf Arab oil producers has overtaken official lending rates, encouraging borrowing for investment in assets such as real estate, which is the main driver of the surging cost of living across the region.

Gulf Cooperation Council (GCC) central banks say that they remain committed to the dollar peg for now, but will leave the door open for coordinated currency revaluations in the future, to tackle rising inflation.

China in no hurry to buy credit crunch bargains

China is taking a more cautious approach to making investments on the belief that the worst of the subprime crisis is still yet to come (Reuters):

Beijing’s reluctance to buy into Citigroup coincides with growing expressions of concern by Chinese officials about the seriousness of the credit crisis. “The subprime loan issue has planted a ticking timebomb in the global financial markets. It now seems the impact is much more serious than the market had previously expected. I don’t think it will be over any time soon,” Vice-Finance Minister Li Yong said at a recent forum.

Abu Dhabi announces $15 billion clean energy fund, world’s first carbon neutral city

Abu Dhabi decides to invest in the energy technologies of the future (BBC):

The government of Abu Dhabi has announced a $15bn initiative to develop clean energy technologies. The Gulf state describes the five-year initiative as “the most ambitious sustainability project ever launched by a government:”. Components will include the world’s largest hydrogen power plant. The government has also announced plans for a “sustainable city”, housing about 50,000 people, that will produce no greenhouse gases and contain no cars.

Some recent stories of interest:

• Davos-Sovereign wealth funds this year’s most in-demand guests: (Reuters)
• Economic uncertainty to dominate Davos: (Financial Times)
• One year on and the mood among bankers at Davos has taken a serious turn: (Times Online)
• China Investment Corp – transparency, accountability constitutional impossibilities: (Guardian Unlimited)
• China turns risk averse as capital outflows rise: (Financial Times)
• The new (financial) world order: (RGE Monitor)
• Silence not golden for sovereign funds: (Financial Times)
• A Guide to Speed Dating With Sovereign Funds: (NY Times Deal Book)
• Who’s afraid of Middle East money?: (Business Week)
• Regulators should intervene in bankers’ pay: (Financial Times)
• The Growing Power of Petro-Islam: (Newsweek)
• Subprime Nation: (Real Clear Politics)
• Abu Dhabi fund to break silence: (Arabian Business)
• ‘Green city in the desert’ for Abu Dhabi (Arabian Business)
• Gulf oil boom spreads to poorer lands: (Financial Times)
• President Bush Questions Saudi Ability to Raise Oil Supply: (Naked Capitalism)
• The Construction Site Called Saudi Arabia: (NY Times)
• Gulf Cooperation Council-Iran Watch: (Abu Aardvark)
• US Secretary of Defense: Iran a challenge, not a threat: (Inter Press Service)
• MEMO to US Presidential Candidates RE Middle East Policy: (Time)
• Red, White, and Blue Tag Sale: (NY Times)
  

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Charlie Rose, hands down the best interviewer in the business, had Landon Thomas of the NY Times and David Enrich of the WSJ on his show last night discussing SWFs. They hit on most of the major themes (SWFs bailing out the US banking industry, reverse globalization, the SWF put) in the news recently (it’s the first segment, about 15 minutes long):

Enrich made an interesting comment about emails that he receives after writing articles about SWFs investing in US corporations. He says that many people complain about the US “selling out to foreigners” and “needing to learn Chinese and Arabic in the next ten years”. Thomas followed up by saying that there’s a xenophobic element in that type of criticism and the US isn’t as global as it thinks it is, especially when compared to places like London, Hong Kong, and Singapore. Hillary Clinton’s pandering at the last Democratic debate certainly speaks to these points.

During Tuesday’s Democratic presidential debate forum in Nevada, Brian Williams of NBC interjected the issue of sovereign wealth funds investing in the US economy into the debate when he directed the following question to Hillary Clinton (Full transcript):

BRIAN WILLIAMS: This evening on NBC Nightly News, our lead story was about the fact that Citigroup and Merrill Lynch have both gone overseas, as some put it hat in hand, looking for $20 billion in investment to stay afloat from, among other things, the government of Singapore, Korea, Japan, and the Saudi Prince al-Waleed, the man — Rudolph Giuliani turned his money back after 9/11.

 

This is — strikes a lot of Americans as just plain wrong. At the end of our report, we said this may end up in Congress. What can be done? And does this strike you as fundamentally wrong, that much foreign ownership of these American flagship brands?

This is a textbook example of a loaded question and Hillary, never one to shy away from an opportunity to pander, didn’t disappoint with her answer:

SEN. CLINTON: Brian, I’m very concerned about this. You know, about a month and a half or so ago, I raised this concern because these are called sovereign wealth funds. They are huge pools of money, largely because of oil and economic growth in Asia. And these funds are controlled often by governmental entities or individuals who are closely connected to the governments in these countries.

 

I think we’ve got to know more about them. They need to be more transparent. We need to have a lot more control over what they do and how they do it. I’d like to see the World Bank and the International Monetary Fund begin to impose these rules. And I want the United States Congress and the Federal Reserve Board to ask these tough questions.

I get Hillary’s overall political strategy and I understand that her statements during the campaign mean essentially nothing given her record of not saying anything substantive without extensive polling and focus group data. I even think her strategy is ultimately going to work. However, the problem with this approach to policymaking is that your agenda is going to be influenced by public sentiment rather than what’s right for the country. It’s sheer lunacy to take advice on international trade from the American public. If politicians want to deter foreign investment the least they can do is tell Citi, Merrill, Morgan Stanley, and all the other cash strapped companies where they can go to get financing, if SWFs are off limits.

The issue of SWF motive and intent deserves a much deeper look (which I am planning on doing in the near future) but in a nutshell the track record of sovereign investors very clearly demonstrates that their investment objectives have been the same as those of large pension and mutual funds. Government-sponsored investors in Asia and the Middle East have been among the largest holders of US government debt for several decades. These holdings have given them ample opportunity to do sinister things and cause substantial harm to US economic and geopolitical interests. The fact that they haven’t demonstrates what their true intents are; getting a good return on investment.

It’s important to note that Hillary’s logic would also apply to preventing and/or limiting foreigners from buying US government debt and US dollars. That would be a very, very bad thing. Again, this issue is much more complex and has many more layers that I will be exploring in greater depth very soon.

Back to the debate. Barack Obama gave a much more thorough and well-thought out answer to the question, even acknowledging that SWFs are bailing out the US banking industry. He also comments on one of the root causes of America’s current economic difficulties (dependency on foreign, fossil-based fuel):

SEN. OBAMA: Well, it’s not a rebuttal. I just want to pick up on a couple things that have been said.

 

Number one, part of the reason that Kuwait and others are able to come in and purchase, or at least bail out, some of our financial institutions is because we don’t have an energy policy. And we are sending close to a billion dollars a day.

 

And this administration has consistently failed to put forward a realistic plan that is going to reduce our dependence on foreign oil, is going to invest in solar and wind and biodiesel. You look at a state like Nevada. One thing I note is folks have got a lot of sun here, and yet we have not seen any serious effort on the part of this administration to spur on the use of alternative fuels, raise fuel efficiency standards on cars. That would make a substantial difference in our balance of payments, and that would make a substantial difference in terms of their capacity to purchase our assets.

 

And the second thing I just want to point out is that the — the sub-prime lending mess, part of the reason it happened was because we had an administration that does not believe in any kind of oversight. And we had the mortgage industry spending $185 million on lobbying to prevent provisions such as the ones that I proposed over a year ago that would say, you know, you’ve got to disclose properly what kinds of loans you’re giving to people on mortgages. You’ve got to disclose if you’ve got a teaser rate and suddenly their mortgage payments are going to jack up and they can’t pay for them.

 

And one of the things that I intend to do as president of the United States is restore a sense of accountability and regulatory oversight over the financial markets. We have the best financial markets in the world, but only if they are transparent and accountable and people trust them. And increasingly, we have not had those structures in place.

For what it’s worth, his understanding of the subprime crisis is much more nuanced than Hillary’s (Wall St made bad bets)……or is Hillary just pandering to the lowest common denominator again by bashing Wall St?

Will President Bush’s sympathetic attempts to immerse himself in Arab culture help convince the Saudis to take measures that can lower the price of oil? Probably not.

Doing the traditional Arab sword dance:

Wearing a traditional Arab robe:

Some recent stories of interest:

• Gulf States to stay on trail of foreign companies: (Financial Times)
• A Closer Look at Sovereign Wealth Funds – Secretive, Powerful, And Huge: (Knowledge @ Wharton)
• Buffet says he turned down investments in financials: (Bloomberg)
• Sovereign funds invest where Buffet won’t: (Bloomberg)
• China and the Arabian Peninsula as market stabilizers: (Stratfor)
• The price of oil and nationalism: (Economist)
• Canada is ‘anxious’ to have investment from China: (Bloomberg)
• No sovereign wealth fund for Canada: (Bloomberg)
• Bush’s “New Middle East”: (Time)
• Abu Dhabi – East Leans West: (City Journal)
• The Dubai phenomenon: (Bitterlemons-international.org)
• How Arab Countries are Coping with Globalization: (Knowledge @ Wharton)
• Can the Middle East Sustain Democracy?: (Middle East Strategy at Harvard)
• The Arabs should stop whining: (Haaretz)
• Sovereign Wealth Funds making ‘good’ investments in US banks: (Emirates Business 24/7)
• Americans sold out to foreign firms at record rate: (Bloomberg)

I’ve been predicting that Hillary would win the presidency for some time now primarily because the establishments (media, financial, military-industrial, special interests, DC and NY elites, et al) were all behind her. But I would LOVE to be proven wrong. Barack Obama is a once in a generation political personality. If he ultimately wins the presidency, the electrifying speech he gave after his victory in Iowa will go down in history as a major turning point in American politics. It’s a must see, check it out:

The US needs to move beyond the petty partisan bickering that has plagued its’ political arena for the last decade and a half. There’s a clear distinction between principled partisanship (greater electoral competition, encouraging disagreement and dissent) and hyperpartisanship (avoiding competition, destroying opposition, silencing dissent). That speech is all one needs see to believe that Obama can be the catalyst that moves the country into the post-hyperpartisanship era.

Also, his background and rhetoric suggest that he likely will not be reflexively xenophobic about SWF investments in US companies (trying to keep things on topic!).