To Court or Shun the Wealth of Nations

Sovereign wealth funds have emerged in recent months as the world’s power brokers. They have used their tremendous wealth to make big cross-border investments and prop up some of Wall Street’s best-known firms.

The New York Times recently published insightful article:

"A PROMINENT American financier, weary from weeks on the money trail that leads through Abu Dhabi, Riyadh, Doha and Dubai, called in recently with these impressions from the road: “They are scratching their heads, they don’t want to be underappreciated or made a fool of,” he said of the executives managing more than $1 trillion in sovereign and central bank funds.

“They invest in these financial institutions, lose their shirts and then they are criticized in Congress.” They are really upset, he said.

And get this, he added: “If you are a Saudi, you have to get your visa signed off by Homeland Security. I mean, why would you want to bail out a bank — you couldn’t even come to the closing dinner.”

The relationship between client and banker is perhaps the most delicate of Wall Street’s minuets, so this executive asked to remain anonymous.

But his concerns are shared by more and more Wall Street executives who criticize the increased scrutiny imposed on sovereign funds, which invest the wealth of their governments. The scrutiny ranges from calls for increased transparency to Congressional inquiries into their tax status, and runs the risk of driving away the world’s largest pool of capital just when the United States economy needs it most.

“Why are we attacking sovereign funds when the core problem is hedge fund transparency,” said Laurence D. Fink, the chief executive of BlackRock, which manages $1 trillion in assets, and who has sovereign funds among his largest clients. “No one questioned them when they bought the billions of dollars of our bonds. I mean, they are financing our deficit. What this scrutiny will do is force them to invest elsewhere.”

As always with Wall Street, there is much self-interest going on here. For decades, sovereign funds, which now top $2 trillion in assets and are expected to surpass $12 trillion by 2015, have been major clients of financial firms. According to a recent survey, half of that $2 trillion is externally managed.

Besides paying fees, funds have become something of a lender of last resort for banks traumatized by the credit crunch. The Abu Dhabi Investment Authority, managing an estimated $600 billion to $800 billion, has paid $7.6 billion for a 4.9 percent stake in Citigroup.

The Kuwait Investment Authority, the oldest of all the sovereign funds, which manages about $250 billion, has invested $5 billion in Citigroup and Merrill Lynch, while Morgan Stanley and Blackstone have received cash infusions from the China Investment Corporation.

All told, according to Dealogic, a financial services research firm, sovereign funds invested $48 billion in deals in 2007 and $16 billion so far this year.

Still, there may be something to Wall Street’s lament.

With the balance sheets of many investment banks exposed to toxic, illiquid mortgage-linked securities, and with the collapse of Bear Stearns so fresh, no one is discounting the possibility of more visits by chief executives to distant capitals. The disclosure on Tuesday that UBS will seek new funds of about $15 billion underscores this view.

The question is whether the funds, especially those in the Middle East, where capital is accumulating the fastest and where sensitivities surrounding disclosure have been most acute, will be as eager to invest the second time around.

Citic Securities, an investment bank with ties to the Chinese government, provided a vivid reminder of the perils of buying stakes in Wall Street banks before the depths of their problems are known. Citic committed to invest $1 billion in Bear Stearns, but luckily never closed the deal.

What sovereign funds will do is a question that looms all the larger, given that the United States economy is weak and growth remains relatively vibrant in economies like those of China, India, Brazil and Turkey.

“There is a concern in the financial community that there have been signals of hostility to sovereign wealth investors,” said Todd M. Malan, the president of the Organization for International Investment, a lobbying group representing corporations investing in the United States. “That has the potential to be negative for the U.S. economy at a moment that we need foreign investment.”

There have been recent signs of an accommodation addressing concerns in Washington that the funds need to disclose more. For their part, the funds want to preserve their tradition of not showing too much of their investment hand. Abu Dhabi and Singapore reached an agreement with the Treasury in which their funds would invest using commercial, not political, criteria and the United States would not impose restrictions on such investments.

While the accord stated the obvious — the two funds are recognized as the most professional of the sovereign funds — it was hailed by lawmakers. Still, rumblings persist that Congressional inquiry may continue.

Earlier this month, the two ranking members of the Senate Finance Committee sent a letter to the Joint Committee on Taxation, a nonpartisan group in Congress that monitors tax policy, asking that it examine how these entities are taxed so as to help “understand the role of tax policy in the sovereign wealth fund puzzle.”

Currently, there is no tax imposed on passive income accruing to foreign governments from investments in the United States. But any hint that sovereign funds may have their tax status questioned would be one more reason for them to take their business elsewhere.

“These inquiries are broadly healthy,” said Douglas Rediker, a former investment banker who studies sovereign funds for the New America Foundation. “But we should be doing our fair share to see that we get investment rather than pushing it away.”

The suspicion surrounding these funds has mainly focused on the Middle East — a holdover, perhaps, from the failure of the proposed sale of six United States seaports to DP World of Dubai.

Saudi Arabia, the United Arab Emirates and Kuwait are by nature cautious, sensitive to maintaining the broad contours of their long strategic relationship with the United States. Even so, some comments by the executives of the funds betray frustration.

“Sovereign wealth funds have been found guilty before being proven innocent,” said Muhammad al-Jasser, the vice governor of the Saudi Monetary Agency, earlier this year. The agency oversees $300 billion in government funds and has yet to make a publicly disclosed investment in a troubled American financial institution.

“There is a lot of worry about sovereign wealth funds, but all of them are assumptions,” said Bader al-Saad, who heads the Kuwait Investment Authority, at the World Economic Forum in Switzerland in February.

So far, there is no sign of a buyers’ strike. And the region’s continued support of a policy that links Middle East currencies to the sinking dollar suggests a willingness to help United States financial policy.

But, as in all complicated relationships, there are limits.

“Since 9/11, Middle Eastern investors feel very frustrated in how they have been treated in the U.S.,” said Shibley Telhami, a professor of Middle Eastern studies at the University of Maryland. “The question is if the lingering bitterness from the port deal is going to outweigh the stretched hand of needy institutions. So far, it has not.”

/By Landon Thomas Jr., The New York Times/