...Sovereign Funds: Bound to Raise Suspicion

$414 billion for stakes in American companies and other assets in 2007, up 90% from the year before.

As recently as a year ago – and despite that some have been in existence since as long ago as the 1950s – the term “sovereign wealth fund” (SWF) was unknown to all but central bankers. These are the huge foreign government pools of money that have since become page one news, thanks to their multi-billion dollar bailouts of U.S. financial firms [< sidebar].

Aside from wounded pride, as we watch large chunks of iconic American financial firms fall into foreign hands, what's wrong with that?

Everyone welcomes foreign investment. It strengthens our economy, creates jobs, and it could be said that SWFs are the best kind of investor from a corporate point of view: long term and undemanding of board seats and even voting shares. Yet they are almost designed to raise suspicions.

Beset with subprime losses, credit paralysis, and the looming threat of credit default swaps, American banks are not today's prime money-making opportunities. So why did the SWFs choose our financial companies, investing in haste, with next to no prior analysis? “There has to be a political objective over and above the rate of return” was Felix Rohatyn's view in a New York Times interview. Rohatyn, a managing director at Lazard Frères known for his role in preventing the bankruptcy of New York City in the 1970s, and subsequently ambassador to France, told Business Week, “This is capital we need desperately, but I don't think we should have any illusions that these are totally benign investments…You don't need to appoint two directors to a board to have influence when you own 10% of the company”. To think that their views will be ignored is delusional.

New York Senator Charles Schumer makes the case that, “sovereign wealth funds, by definition, are potentially susceptible to noneconomic interests; the closer they come to exercising control and influence, the greater the concerns we have”.

The concerns are many. Lawmakers and regulators think we should throw up barriers to prevent control of our financial institutions or access to companies producing military technology. Nor should we, for example, allow Russia to buy an energy company, given their having wielded natural gas as a weapon against Ukraine and Belarus. Russia and China in particular are viewed as having a political agenda alongside an economic interest.

Of great concern is that ownership by government sovereign funds amounts to nationalization of western assets. It raises the specter of interference in free markets. These funds are opaque; no one is privy to their investment strategies. They are subject to the dictates of their governments, which are not always sympathetic to western investor interests. There is the fear that shifts of these massive funds in and out of investments could roil the economies of the countries in which the assets reside. Another Times article wondered whether, faced with an economic emergency, Treasury Secretary Henry Paulson might find himself not just calling the major central bankers but would have to win the cooperation of directors of the SWFs as well. Might that be happening now?

Then there is the fear that ownership will expand to the point that sovereign funds will exert political influence in the countries where they control massive assets. Imagine that, in return for keeping money in Treasury bills to finance U.S. debt as it hurtles toward $11 trillion, a sovereign fund exerts secret pressure on