The Sham of Sovereign Wealth Fund Negotiations

The Wall Street Journal reports today in “U.S. Pushes Sovereign Funds To Open to Outside Scrutiny,” that the US Treasury Department talking to two large sovereign wealth funds, Singapore’s Temasek and the Abu Dhabi Investment Authority, as the first steps in a process to “”draft rules to oversee the behavior of such funds, without discouraging them from investing.”

Let’s see if I get this straight. The US is running a chronic current account deficit, which means we are dependent on the kindness of foreigners to maintain our lifestyle. In other words, we have to run a capital account surplus, which is tantamount to having other countries buy our real or financial assets. And while the fall in the dollar has reduced our current account deficit somewhat, it’s still at a high level. Ergo, we need our money fix.

Brad Setser, who monitors the international capital data closely, has been reporting for some time that the private demand overseas for US assets has fallen considerably. The key buyers now are foreign governments. And those governments, who used to be content to buy low-returning Treasury bonds, are now looking to diversify their holdings and earn higher returns. Enter the sovereign wealth funds.

What is comical about this whole idea is the idea that we have any say in this matter. Of course, the US can nix individual deals, as we did to Dubai Port World’s purchase of UK P&O Ports. Dubai Ports had to divest five US port operations; the UK imposed no such requirement. Similarly, the US blocked Chinese oil company CNOOC’s bid for Unocal blocked, which ruffled quite a few feathers.

But we’ve already let foreign banks make substantial investments into our troubled financial sector, which one can argue gives them strategic leverage. Yes, these are minority stakes, the investors don’t hold any board seats. Nevertheless, as eminence grise Felix Rohatyn pointed out, “You don’t need to appoint two directors to a board to have influence when you own 10 percent of the company.”

Indeed, when Citi’s board was ready oust Chuck Prince, Sandy Weill paid a visit to the bank’s biggest shareholder, Prince Alwaleed, to make sure he was on board. Alwaleed owns a mere 3.6%, smaller than some of the stakes recently acquired.

So consider the elements of fantasy at work in this discussion over these efforts to set guidelines on SWF investments:

1. We are pretending that a large stake in and of itself won’t lead to influence

2. We are pretending that we have negotiating leverage in this matter. We don’t. We need the dough desperately. Unless we get our saving rate up to make ourselves more independent (which will almost certainly lead to a recession or a very prolonged period of low growth), we are in no position to place restrictions on capital inflows (except now and again, for show)

3. We are pretending that any commitments made are meaningful. Let’s say the SWF decide that it’s politically expedient to play nice and agree to certain measures, like allowing for a certain amount of transparency and publishing their fund objectives, which will of course be to earn a certain level of financial return and will have nothing to do with getting access, say, to resources or technologies. First, there is no way to make the funds conform to their statements. Second, even if the funds are completely sincere when they make these representations, a change in leadership can lead them to repudiate their former policies, after they have acquired substantial positions.

So these negotiations are really theater for the benefit of the American public. We’ll plead in private, if need be, for the SWF to give us something to keep Congress from interfering, and they may well agree to cosmetic measures. Or, if they really have no interest in going along, they’ll just string out the discussions until our financial sector has another ratchet down and the wounded players have nowhere else to turn.

Oh, and another amusing and revealing tidbit from the Journal story:

Abu Dhabi’s fund has assets of about $900 billion; Singapore’s is estimated to have $300 billion. “The two funds are some of the most mature, well-known and credible sovereign-wealth funds,” said Treasury Undersecretary David McCormick in an interview yesterday. “We are actively trying to have many conversations” with different funds.

The claim that these fund is “mature, well-known, and credible” is mind-bogging (although those terms are so carefully chosen as to be close to meaningless).

Ted Truman, a former senior staff member at the Treasury Department and the Fed, recently developed and published a scorecard for the Peterson Institute that evaluated 32 SWFs (see here, page 12 for the rankings). On a 25 point scale, New Zealand was the best, earning 24 points. Qatar was second to worst, earning a mere two points. It got zero for governance and zero for transparency. This Singapore fund (note this fund is different from another Singapore SWF, Temasek, which got much higher marks) is third from the worst, again scoring zero on transparency. While the story does mention these poor rankings, it does so much later.

Also note that the story several times mentions that at least 11 nations that are recipients of SWF investments have made some restrictions on direct investment. While narrowly true, the “11 nations” is a bit misleading in terms of the US’s stakes in attracting foreign capital. It creates the impression that all have common cause when the reality is more complex. We now absorb 75% of the world’s savings. Most other countries can afford to say no; it’s not a luxury we have.

From the Journal:

Seeking to head off a political backlash against huge investments in Western companies by Asian and Middle Eastern government-run investment funds, the U.S. is prodding two of the biggest funds to embrace a set of promises that they won’t use their wealth for political advantage…..

With encouragement from the U.S. and Europe, the International Monetary Fund is aiming to put together by the fall what it calls a voluntary code of “best practices.” The code would cover how sovereign-wealth funds are structured, how they invest, and how they disclose information, among other things. The Treasury meeting appeared to be an attempt to push forward that process. “Discussions are obviously useful,” says John Lipsky, the IMF’s deputy managing director, adding that the fund wasn’t involved in the session.

Mr. Lipsky says the IMF wants to help the funds reach consensus on issues such as transparency, governance, disclosure and fund organization…”We’ll come up with something useful,” says Mr. Lipsky. “It’s in everyone’s interest.”….

Officials in many national capitals are increasing pressure on the funds to agree to revamp their practices. The efforts come amid rising worries about the political implications of foreign investment. Over the past two years, at least 11 major nations, including the U.S., have passed or debated laws to restrict foreign investment….

The European Commission’s statement on the behavior of sovereign-wealth funds, due to be released tomorrow, will urge the funds to reduce their “opacity” so their investments can be “demystified,” according to an individual briefed on the matter…

But the commission will also make clear its commitment to remain open to foreign investment. It will urge that investments be judged on national-security grounds, not on more amorphous ones, according to a European Union official…

The Treasury meeting in Abu Dhabi was another effort to persuade the funds to change. The Abu Dhabi and Singapore funds are considered significant because of their size, the difference in the sources of their capital — Abu Dhabi’s money comes from oil; Singapore’s from export revenue — and their unwillingness thus far to disclose much about their operations. In a ranking of the openness of 32 sovereign-wealth funds by former IMF official Ted Truman, Abu Dhabi’s fund ranked last, and Singapore’s ranked third to last. Any agreement by those funds to make their operations more public could have wide influence among other funds….

When contacted about the matter, a representative of Singapore’s fund referred a reporter to comments made last month by the fund’s deputy chairman, Tony Tan, in Singapore’s Straits Times newspaper. Mr. Tan said the fund was ready to make changes, including regularly announcing its rate of return on investments and clarifying the objectives of those investments. But the fund wouldn’t disclose all its purchases, he said, because that would put it at a “competitive disadvantage” to hedge funds and private-equity funds.

Abu Dhabi’s fund, so far, hasn’t opened its books. But it may be encouraged to do so by the example of state-controlled companies in Dubai, a 90-minute drive away. Recent deals by those companies used borrowed money, which obligated them to give bankers and other lenders access to their finances. Abu Dhabi and Dubai are part of the United Arab Emirates.