Black and White Program

The Focus of Discussion Regarding Sovereign Wealth Funds

February 4th, 2008 by John Eastman

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Several months ago, mentions by the media of the term Sovereign Wealth Funds (SWF) were few and far between. SWF commonly was thought of as an acronym for Single White Female, but a new common reference to SWF may be on the horizon. Currently, SWFs with estimated values of two to three trillion U.S. dollars are owned by foreign countries or, in other words, state owned. Approximately 36 countries or regions have funds, which have either operated under the radar, or are largely dormant as far as U.S. investments are concerned.

But a few high profile transactions involving Merrill Lynch and Citibank at an estimated 21 billion dollars have stirred up the media of late to focus on the nature and ownership of SWFs. The news of foreign state-controlled funds investing billions into U.S. financial institutions and, in fact, stepping in as saviors when these institutions have a severe liquidity crisis, is now a significant topic. Fears of foreign policy influence, protectionism, and now, the asking of countries with these funds to issue a best practices type of policy to assure that they do not damage or seek ill intentions from the U.S. is an ongoing discussion. A panel on this topic was convened at the recent World Economic Forum in Davos, Switzerland and has provided some healthy discussion, views, and information from parties on all sides of this issue.

What the media has not focused on are the underlying reasons for the U.S. financial markets needing a bailout. Furthermore, what signal is being sent to the rest of world with regards to the U.S. being a global power, a leader, and the biggest promoter of free markets and capitalism in the world?

The stated reason as to the root of the liquidity problem is the sub-prime mortgage loan crisis and the subsequent credit crises. The buying, repackaging, and selling of these high risk mortgages, which are now severely underperforming, is what has landed the U.S. financial institutions in red ink to the tune of billions of dollars in losses and write-offs. The mortgage loans, stacked with unbearable interest rate and payment increases, were made to high-risk borrowers with negative credit conditions. With property values dramatically falling and payment requirements significantly increasing, borrowers have defaulted, leading to widespread write-offs of 10 billion dollars and growing. Some say we are barely 40% of the way through this crisis.

While the media seems focused outward on the emergence of SWFs and their implications at the state scale, some inward thinking may be in order. Intense scrutiny and public attention should be focused on those responsible for the credit crisis as opposed to the diversion of SWFs. Who conceived of these types of mortgage instruments? What motivated them?

Note that the Merrill Lynch and Citibank deals have already been made and equity positions already taken, perhaps with no regards to U.S. sovereignty or foreign policy. Major U.S. institutions are in crisis mode. These are deals that have to be made for survival.

A refocus on the mistakes that have been made by the powerful people at the levers of these U.S. institutions needs to occur.

What message is being sent to U.S. allies around the world with regards to financial soundness, leadership, and judgment?

Has greed and profiteering for fees been aimed at less fortunate Americans again?

What message is being sent to the growing list of U.S. critics?

Does the world’s financial community view U.S. banks as the Achilles heel of the system?

Ironically, the root of this problem is the ingenuity of none other than the U.S. financial institutions themselves. No foreign power or state invented sub-prime mortgage deals. No foreign power or state marketed these instruments aggressively to consumers with poor credit; sometimes the consumer did not fully understand what they were getting into. No foreign power or state profited via fees from almost every segment of the high-risk mortgage process.

While promises of new financial controls, oversight boards, and policies to prevent this from happening again may come, the messages have already been sent to the global community.

These messages do not speak highly of our state.

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