When large foreign investors and sovereign wealth funds — state-owned investment funds composed of stocks, bonds and other financial instruments — came to the rescue of U.S. banks and brokerage houses a year and a half ago, Wall Street cheered.
The consensus was that their billions gave the U.S. an easy way out of what might have been even more dire straits. “Americans as a nation should be very happy that someone buys their garbage,” says Marc Faber, a Hong Kong-based investment advisor, looking back recently on the spring's events.
But in finance as in physics, every action leads to a reaction — especially since these purchases came on top of the $1.3 trillion they already owned in Fannie Mae and Freddie Mac debt. Some economists argue that those knock-on effects may change the markets going forward.
Once burnt, twice wary
Perhaps the most near-term consequence is that given the lousy track record of that “garbage,” foreign investors seem reluctant to buy more now. Even huge foreign funds take notice when an investment like the $20 billion poured into Citigroup last November is rewarded with a 58% decline in its share price — from $37.73 down to $15.87 in September.
After returns like that, it's not surprising that sheikhs in shining armor were in short supply this September as Lehman Brothers sank toward Chapter 11 and Merrill Lynch resorted to a last-minute buyout from Bank of America.
However, declining demand for Fannie, Freddie, and financial stocks will almost certainly mean rising demand for something else. Governments in the Middle East and Asia are sitting on nearly $7 trillion in capital gained primarily by selling a lot more to us than we sold to them, and they're less interested in keeping it in U.S. Treasury bonds.
Edwin Truman, an economist at the Peterson Institute in Washington, D.C. who specializes in sovereign funds, believes that they tend to invest in ways similar to university endowments.
If that's the case, he says, you might expect to see more purchases of high-quality buildings. However, sovereign funds seem to be as averse to commercial real estate as anyone else right now — another reason that Lehman Brothers had a hard time finding a buyer for its $25 billion real estate portfolio.
Leveraging up, politically
A second side effect of these huge foreign investments may be more political leverage for the investors. Some economists, including Larry Summers, Harvard University economics professor and former U.S. treasury secretary, asked earlier this year what would happen if a foreign government that held a lot of debt in a troubled U.S. company asked our government to bail that company out.
Actually, we now have a pretty good idea. You say, “Right away, sir” — in Chinese. At the end of August, the Bank of China, the country's third largest bank, announced that it had shaved its holdings of Fannie Mae and Freddie Mac debt by more than 20% over the summer.
That news, coupled with growing aversion among Asian investors generally to Fannie and Freddie, appears to have been enough to push the U.S. Treasury to take over the mortgage giants.
Less than a week later, after years of dithering about the ailing government-sponsored enterprises, Treasury Secretary Hank Paulson announced his decision to place the mortgage giants into conservatorship, effectively guaranteeing the foreign investors' $1.3 trillion.
James Carville, the former Clinton strategist, once said, “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everybody.”
Now Carville might want to rethink his wish. When it comes to intimidation, being a sovereign fund may have even more potential than the bond market.
Bennett Voyles is a veteran commercial real estate reporter and NREI's Paris correspondent. For questions or comments, readers can e-mail him at firstname.lastname@example.org.