Stop worrying about the value of your house, or your 401(k), or the economy. Instead, worry about one of the long-term consequences of the drying up of the usual sources of funds for private equity entrepreneurs.
Long after the last undercapitalized mortgage broker has departed the scene, and long after the teenage model builders have left their hedge funds for other employment, one serious consequence of the current repricing of risk will remain — the investments of the sovereign wealth funds (SWFs) that will fill any financing gap faced by private equity operators.
The combined assets of these funds are estimated by the U.S. Treasury at between $1.5 trillion and $2.5 trillion, more than the total investment of all the world’s hedge funds. Morgan Stanley estimates that their assets will soar to $12 trillion by 2015.
These assets have been accumulated by the oil-exporting nations and other governments, such as China, that have been running huge trade surpluses. Treasury Secretary Hank Paulson, who says, “We must … welcome foreign investment,” nevertheless has asked the International Monetary Fund and the World Bank to draw up guidelines for investments by government-run funds.
The end to free and easy credit has reduced the flood of funds into private equity deals to a trickle, prompting the resilient entrepreneurs who make up the private equity business to shop where the money now is, the SWFs.
The history of these funds suggests some cause for concern. Norway dumped its holdings in Wal-Mart because it disapproved of the company’s efforts to maintain a nonunion shop. And communist China, Russia, Saudi Arabia and anti-American Venezuela are not seeking merely to maximize returns. Wen Jiabao, Vladimir Putin, the Saudi royal family and Hugo Chávez are not Warren Buffett with foreign accents. They are political, not economic, actors.
Until now, much of the wealth of these nations has been invested in the IOUs of the U.S. government. That created a risk: Creditors who are unhappy with U.S. foreign policy might dump their dollars and Treasury bills, driving up interest rates in America to recession-inducing levels. But that would have caused huge losses to the dumpers, since the value of their dollar and dollar-asset holding would drop like a stone. So the risk to the U.S. was tolerable.
Now things have changed. The private equity crowd is wooing SWFs, and these government-funded organizations “are on a shopping spree,” reports an unconcerned, free-trade-dogmatist Economist.
These completely nontransparent entities are in a position to create two sorts of mischief. First, they can make the recent turmoil in financial markets look like a walk in the park. If the Abu Dhabi Investment Authority, the largest of the SWFs, should find it necessary to unwind a big position, perhaps to respond to some internal crisis, even The Economist concedes “it could start a panic.”
Second, they can invest in security-sensitive companies — Dubai International Capital owns 3 percent of EADS, which makes Eurofighters, and Vneshtorgbank, a state-owned Russian bank, has bought another 5 percent, purchased with $1.2billion of its petrodollars.
Anyone who thinks Putin doesn’t intend to use his government’s investments for political purposes when it suits Russia’s foreign-policy interests has not been following his moves in the European energy market.
Or that the China Development Bank had purely financial objectives when it bought a piece of Barclays bank, and obtained a seat on the board, has not read its charter, which requires it to pursue “the state’s policies to … build a harmonious society,” a goal that can reasonably be interpreted to include pressuring Taiwan to rejoin the communist mainland by withholding investments.
Lest all of this sound like protectionist paranoia, consider the views of two confirmed free traders. Lawrence Summers, deposed president and now a professor at Harvard, points out that capitalism depends on shareholders forcing companies to maximize profits and shareholder value, but “it is far from obvious that this will … be the only motivation of governments as shareholders. They may want … to extract technology or to achieve influence.”
And Jeffrey Garten, professor at the Yale School of Management, thinks it reasonable to wonder “what the governments of countries such as China, Russia and Saudi Arabia may look like a decade from now, and their political motivations might be.”
No need to wonder about a decade hence. We know what their motives look like now. That should be enough to make Western governments re-examine existing policies that are so welcoming to investment by sovereign wealth funds.
Examiner Columnist Irwin Stelzer is a senior fellow and director of the Hudson Institute’s Center for Economic Policy
