El-Erian: Sovereign Funds Saved Wall Street

[nmap]

This hints at the possibility that a variety of other nations, each with their own agendas, may be gaining tools with which to influence our national policies. Continued trade deficits may increase such influence.

LINK



Tuesday, May 27, 2008 2:18 PM


Investments in major financial institutions by sovereign wealth funds over the past year helped save the U.S. financial system from a meltdown, says Mohamed El-Erian, co-CEO of Pacific Investment Management Co.

“Imagine what the U.S. financial system would look like if $69 billion in capital did not come in November, December and January from the sovereign wealth funds,” El-Erian, former head of Harvard University’s endowment, said at a recent investment conference.

“It would have been a lot messier. The credit crunch would have been a lot worse. The de-leveraging would have been a lot more severe.”

U.S. financial institutions have suffered more than $160 billion in losses and write-downs since the subprime mortgage crisis began last year. So the investments by foreign funds played a major role in shoring up the balance sheets of these troubled firms.

The investments include:


• Abu Dhabi Investment Authority’s $7.5 billion purchase of Citigroup convertible securities in November.

• Kuwait Investment Authority’s $3 billion purchase of Citigroup stock and $2 billion purchase of Merrill Lynch stock in January.

• Temasek Holdings of Singapore’s $4.4 billion purchase of Merrill Lynch stock in December.

• Government of Singapore Investment Corp.’s $6.9 billion purchase of Citigroup stock in January.

• China Investment Co.’s $5 billion purchase of Morgan Stanley convertible securities in December.


Some critics of the funds have expressed concern that they will try to translate their economic power into political power, working against U.S. interests. El-Erian acknowledges this worry, saying the sovereign funds “have an obligation that comes with the new power.”

U.S. and foreign officials have called for the funds to make public all their investments and intentions. In February, the European Commission called for an international agreement to limit the political influence of the funds.

Their financial influence certainly won’t shrink anytime soon. So-called SWFs now control more than $3 trillion in assets, and the International Monetary Fund estimates that total will rise to $12 trillion within four years.

In a recent interview with Reuters, El-Erian also said that the damage from the credit crisis has moved from the financial sector to the consumer sector.

“This one is morphing from a financial sector disruption that hit Wall Street hard to one impacting Main Street, through mounting pressure on consumer confidence on account of both lower growth prospects and higher inflation,” he told the news service.

The Reuters/University of Michigan consumer confidence index dropped to 59.5 in May, its lowest level in 28 years.

The government needs to stabilize the housing sector to pull the economy out of recession, El-Erian says.

“Otherwise, the consumer will face excessive pressure in the form of higher prices, lower availability of credit, declining employment, and the negative wealth effect from falling house prices and higher foreclosures.”

[Razor]

“Imagine what the U.S. financial system would look like if $69 billion in capital did not come in November, December and January from the sovereign wealth funds,” El-Erian, former head of Harvard University’s endowment, said at a recent investment conference.

And imagine what would have happened globally if, because those foreign investments weren't made, America cut its imports significantly in a very short period of time. It wouldn't have only been Americans suffering.

The "good news" behind the slow GDP growth (up from 0.6% in 2007Q4 to 0.9% 2008Q1) is that imports tend to drop, which can (no guarantees) stimulate domestic growth and spending.

[Razor]

From an economic standpoint, our trade deficit (mostly in consumer goods) is good because it fosters the evolution of our economy from production to services, enticing foreign investment.

However, this view must be balanced with an eye towards national security. While divesting our economy of goods production and agriculture may make long-term economic sense, it also creates dependencies with which I'm not very comfortable.