Over the past half-year, several large US-based banks and financial institutions have made it apparent to what effect the subprime mortgage housing crisis and credit crunch have impacted their balance sheets. In response, many of these companies have turned to outside investors to shore up their losses, and in many cases these investors are state-owned. Sovereign wealth funds, or SWFs, have become prominent in the past several years due to their growing numbers and increasing sizes. More recently, as they have bailed out banks such as Citigroup, Morgan Stanley, Bear Stearns, and UBS, SWFs have come under greater scrutiny for two primary reasons. One, as large investors, equivalent to the size of hedge funds, their non-transparent nature is perceived to have potential long-term impacts upon the global economy. In reaction to this perception, many governments in the West have called for greater regulation and transparency in their deals and holdings. Secondly, because many of the these funds are state-controlled and primarly exist  amongst non-democratic governments, the investing rationality is perceived to be non-rational at times, based not on instrumental rationality or economic incentives, but rather on national interests. The primary fear created by this perception is a political one whereby states whose companies sell large stakes to SWFs are highly susceptible to risks of national security when the investment is made in a strategic industry such as energy (as with China's CNOOC and Unocal in the US). The most recent episode of SWF investment involves Merrill Lynch and Temasek, the Singapore-based SWF, which derives its wealth from its large currency reserves.  Today's New York Times and Financial Times report that Tamasek will invest about $5 billion in Merrill Lynch:

From the Financial Times:

Merrill Lynch on Monday sold most of its middle-market commercial finance business to General Electric and confirmed a $6.2bn investment by Temasek Holdings of Singapore and Davis Selected Advisors as the Wall Street bank seeks to bolster its capital base.

The deal by GE to buy the bulk of the business of Chicago Merrill Lynch Capital raises about $1.3bn in capital for other parts of its business.

Merrill Lynch has been among the banks hardest hit by the US subprime mortgage meltdown and is expected to announce billions of dollars in further writedowns in the the fourth-quarter.

“This transaction reflects Merrill Lynch’s continued strategic focus on divesting non-core assets and optimising capital allocation, while also enabling the redeployment of approximately $1.3bn of capital into other parts of our business,” said John Thain, chief executive and chairman of Merrill.

Mr Thain joined the Wall Street bank from NYSE Euronext just three weeks ago.

Temasek, a Singaporean state-owned investment company, will invest $4.4bn in Merrill’s common stock and has the option to purchase an additional $600m of its stock by the end of March.

Merrill sold the stake to Temasek for $48 per share, almost $10 a share lower than the stock’s trading price on Monday.

Temasek was also mooted as a possible investor in UBS and Morgan Stanley, although the banks later confirmed cash injections from the Government of Singapore Investment Corporation and China Investment Corporation respectively.

Davis, an Arizona based fund management firm, will make a long-term investment of $1.2bn.

In terms of the continued debate over transparency and intentions of SWFs, the real issue comes down to one of underlying perceptions and basic assumptions.  The perception of why SWFs are investing is one based upon economics reasons, as well as political motives; but the question must be asked:  Why does such a perception exist?  In many ways this multi-faceted perception is linked to the regime type that dominates the country from which an SWF originates.  In many cases of SWFs, the governments are authoritarian, and both the perceptions of financial and political risks emanate because investment intentions from authoritarian regimes are perceived not to be solely based upon acts of instrumental rationality.  This, however, has not necessarily been proven to be the case. 

The perception of SWFs being a non-rational investor emanates from the basic assumptions that these investment bodies are being administered by individuals who do not act along primary rationales of investing, and that an association between state-ownership and investing bodies may utilize motives based less on economics, and more upon politics.  Neither of these two assumptions has yet to be sufficiently proven as the default modus operandi for SWFs; however, the resulting perceptions of these assumptions have proliferated with the recent wave of SWF investment, especially amongst FDI host countries as in the US.  What remains to be seen is how this new cycle and direction of global investment plays out financially and politically.  Much of what happens, as argued above, will depend significantly upon the underlying assumptions and perceptions surrounding SWF investment, and the resulting state behaviors based upon these perceptions.


Posted by: Brendan P. Geary