Why Sovereign Wealth Funds Are Propping Up the American Financial System

Let’s point out the obvious, when SWFs (no, that’s not your next date) invest in the US by buying real esatate or stakes in financial companies which need infusions of cash to maintain liquidity ratios, they aren’t protecting themselves from US dollar exposure, at least not directly.

Yes, a stake in Morgan Stanley is (probably, and only probably) worth more than holding some structured debt obligations (SDOs) Morgan Stanley sold you, but it isn’t the same thing as reducing dollar risk. Reducing dollar risk would be if SWFs took their trillions of US dollars and started getting rid of them, buying up other currencies.

The problem with that, as we all know, is that it would precipitate a crash in the value of the dollar and because they own so many dollars, they couldn’t sell fast enough to outrun the crash and would probably wind up losing more from dollar devaluation than they’d save in whatever they managed to offload before the crash started.

Which is why you hear everyone and their mother talking about “rebalancing” their portfolios, which is fund manager for “edging towards the door slowly, hoping not to set off a panic that will trample me to death.”

Buying up shares in US companies now is either about trying to buy when things are cheap or it’s about trying to prop up the US financial industry so it doesn’t collapse. I’d say it’s more of the second than the first, because if you want to buy cheap, there are good odds there will be better opportunities down the line — this financial crisis hasn’t played out yet. But when you’re a big player it’s not just about guessing what the future holds, it’s a question of asking yourself “what can I do to change that future to one better for me?” And if you run a SWF you’ve got to figure that anything you can do to keep the US financial sector from collapsing, which you know will shortly be followed by a dollar rout, you have to do. So sure, you can pick up some shares in various financial firms and other assets for less than you could have last year, but that’s not really what this is about. Instead your key motivation is keeping the value of your current assets–still mostly dollar denominated, from crashing out with the US economy.

Sovereign Wealth Funds will grab what they can while it’s cheap, but their main goal isn’t that, their main goal is to make sure US assets don’t get too cheap, because if they do, most of their holdings will be at cents to the dollar–if they aren’t already, which they may well be.

Central governments are responsible for the US dollar having not taken a precipitous plunge in the early 2000’s, they are now doing what they can, through the SWFs they control, to try and stave it off one more time. The dollars they hold are worthless if the system that printed the dollars (the Fed, Fannie and Freddie, Wall Street) goes under, so they’re doing what they can to keep that system’s head above water.

We’ll see if they succeed. If they do, it winds up looking like a bottom fishing expedition that went well. If they don’t, a lot of the nominal value on their books will go away anyway. So they’ve got nothing to lose by trying.

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Ian Welsh

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  • I can certainly see your point as the logical result of these investments by Singapore and China and Dubai. What is debatable is whether there was a conscious decision to do this at these SWFs. The board of directors conversation may have been somewhat different.

    “We have a certain amount of our assets allocated to the dollar. We are trying to reduce this percentage, but still there are hundreds of billions of dollars we have to invest even when we get to the smaller percentage. Within that amount, let’s shift a few billion away from US Treasuries and into this opportunity – otherwise not available to us – to buy an interest in Morgan Stanley.”

    Of course, they should ask themselves what if Morgan Stanley continues to deteriorate. But this may be attractive too, because then they can buy a controlling stake in a major Wall Street firm. Assuming Morgan Stanley can be resuscitated into a healthy investment bank, the SWF gets technology and expertise it could never develop on its own so quickly. The balance of Wall Street power shifts to the East.

    I suspect these funds are much more interested in what they can get long term from Morgan Stanley or Merrill Lynch than in propping up the financial system in the U.S. The latter is attractive too, but as a tacit bonus, nothing explicit.

  • I seem to recall that the decision by China’s SWF to buy a controlling share was a political one — the fund manager was said to have been given his marching orders and was not onside initially.

    However, you may well be right and I may be seeing something that isn’t there even if there is reason for it to be.

  • got their influence by their country’s selling us stuff. If they diversified out of dollars, they couldn’t sell us stuff anymore. That is not going to happen. Right now they have a few too many dollars and are buying assets here.

    Everybody needs to relax as all this gets adjusted and not make dire forecasts. I’m looking for some people to go broke, but the US will still be around, in good shape, for decades to come.


  • I tend to think this is bottom feeding. Morgan Stanely is getting rocked right now, as well they ought to, but does anyone here really predict that they won’t exist in ten years? Merger/buyout/restructuring maybe, but they still have a lot of talented people (believe it or not) who still have a tremendous amount of wealth at their disposal to use to generate more wealth.

    Hedge funds created some weird market dynamics in August that caused a scary market move, but its reasonably well understood now how it happened. The portions of the financial industry that are getting hit with the sub-prime issue are getting rocked as much by uncertainty as anything. Remember, these were derivative and options products… the sub-prime collapse in and of itself is zero-sum. Its the fact that no one is quite sure where the risk is that’s the problem. Perhaps someone a little more knowledgeable could back me up or set me straight on that one, but that’s my impression.

  • Cash or debt, it’s a paper bubble that can only get bigger, until it finally pops. Where would all the government debt be invested if it wasn’t being recycled through the public sector? Do you really think they cured inflation by raising interest rates and causing a recession, which reduced the need for money? What’s the difference between the Fed selling debt it’s holding and the Treasury issuing fresh debt?

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