What's the hottest topic at Davos this year? Probably sovereign wealth funds, those big pools of capital mushrooming in the Gulf, Asia, and elsewhere (BusinessWeek.com, 11/1/07). Conference participants and a large press contingent lined up early to attend a Davos session on the subject Jan. 24.
The funds are controversial in countries like the U.S. because they already have a lot of firepower, and it is growing fast thanks to high oil prices and U.S.trade imbalances. Richard Fuld, chairman and chief executive officer of Lehman Brothers (LEH) said the wealth funds, whose present value he pegged at as much as $3 trillion, could command as much as $20 trillion in five years. "The impact will be huge," he said, though he noted pension funds command some $60 trillion.
While few U.S. and European politicians have raised objections to the large stakes various funds have taken (BusinessWeek.com, 12/7/07) in blue chip U.S. and European banks such as Citigroup (C), Morgan Stanley (MS), Merrill Lynch (MER), and UBS (UBS), greater tensions may well be brewing as the funds grow larger and more ambitious. The notion of foreign entities buying up blue chip assets goes against the grain in the U.S. and other Western countries. Perhaps the greatest danger arising from the huge growth of these funds isn't that they will buy strategic assets in the U.S. and elsewhere, but rather that they will trigger a wave of protectionism that could gum up the international financial system.
Fears Have No Basis
On the Davos panel, only former U.S. Treasury Secretary Lawrence Summers expressed serious concerns about the sovereign wealth funds, and he acknowledged the world was a better place for their having poured money into damaged banks in recent months. Among the concerns the former Harvard University president mentioned was worry that the funds could be used by host governments to exert political clout or otherwise sway decisions in target countries and companies.
Those who spoke for the funds seemed on the defensive, although they were encountering very little criticism from the movers and shakers at Davos. Bader Al Sa'ad, managing director of the Kuwait Investment Authority, which recently bought chunks of Merrill Lynch and Citigroup (BusinessWeek.com, 1/10/08) said, "All the fears about the sovereign wealth funds have no basis and no case to build on."
Muhammad al Jasser, the deputy governor of the Saudi Arabian Monetary Agency, the central bank, which manages most of Saudi Arabia's overseas assets, was more relaxed. But he brushed off Summers' suggestion that the funds would be wise to adopt a good-conduct code to ease worries, claiming there has been huge resistance in the U.S. to regulating hedge funds and rating agencies—even those "who created turmoil in the world economy."
No Different from Many State Funds
For the most part, the kings of Wall Street at Davos said that was fine. Stephen Schwarzman, chief executive of private equity giant Blackstone Group (BX), said he had been dealing with such organizations as an investor for 20 years and, "It was amazing to see them given a new name, 'sovereign wealth funds,'" and become something journalists write about as a threat.
He said there was "virtually no difference" in behavior between the big state funds in the Gulf and Asia and state pension funds in the U.S. that are one of the main sources of funds for private equity firms. China Investment Corp., a state arm, is Blackstone's largest shareholder, but Schwarzman said it doesn't have a seat on Blackstone's board nor does it "try to influence activities."
Ironically, Summers said such passivity was one of the potential dangers the funds posed. A large, passive shareholder might help underperforming management teams stay in their jobs. What could be better for management, he asked, "than a long-term, nonvoting shareholder who if they did desire to liquidate would get murdered in the press?"
Elements of Cross-Border Nationalization
More seriously, Summers worried a government-controlled fund might engage in speculative attacks on another country's currency or take stakes in companies for other motives than purely commercial ones. For instance, he speculated a fund that bought into a large U.S. bank might then pressure the bank to help bolster the developing country's ambitions to be a financial center.
Summers presented this as a hypothetical situation, but Dubai recently agreed to acquire a nearly 20% stake in Nasdaq (NDAQ), the U.S. financial exchange, in part to bolster its own drive to be the Middle East's financial hub. He also said if a sovereign wealth fund invested in a major bank and the bank got in trouble, "There is no question that their head of state and foreign minister are going to get involved" in persuading the host government to bail out the bank. Such investments, he said, "have some element of cross-border nationalizations."
But whether the U.S. can afford to obsess about such concerns at a time when it is running huge trade deficits and several of its biggest financial players are suffering from serious, often self-inflicted wounds, is an interesting question. At the moment, the wealth funds are performing two very useful functions: shoring up the capital base of U.S. and European banks, and recycling current account surpluses. As Kristin Halvorsen, the Finance Minister of Norway, which has a $300 billion fund, said, "They don't like us, but they need our money."