COMMENTARY

Peter Burgess

Capital Has No Homeland

One phrase I have heard frequently from well-to-do Chinese business people is 钱无祖国. Roughly translated into English, this means that “capital has no homeland”; it largely goes wherever it can get the best return for its owners.

The flip-side of this statement is that the nation-state, this political entity which has been so important for the past 500 years, is gradually losing power and influence. As technology enables individuals more and more, governments and large organizations lose power, influence and attraction.

How many bright young people have you met who said “I want to work for a large organization?” In the tech sector, the number is small; most prefer to work at startups. I predict that this trend will soon spread to media and other fields. It’s just easier to get things done and you don’t need to share the profits among as many people.

This is what those who criticize the article about sovereign wealth fund stakes in Google and Apple don’t understand. When a corporation’s shares are traded on the open market, a corporation is no longer just a national entity, it is a global entity. Apple and Google are global corporations, not American corporations. Their owners, shareholders and employees are global, not just American. They just happen to have their main domicile in the US and were first incorporated in the US and are subject to US laws, but that’s it. Only if capital restrictions are put in place can you prevent anything like the scenario I have put forward from taking place. If the US were to do that, it would amount to the US government admitting that globalization, a policy that all US administrations have pedaled to the American people for the past 50 years is wrong and is bad for America.

Doug Rediker has an excellent article about the difference between how national banks and investment banks see this trend. (see below)

If there is one area where many Americans have fallen woefully short it has to do with educating themselves about the importance of managing your finances in a smart manner. Roger Ehrenberg draws an excellent picture of how the subprime mortgage mess grew, and how most Americans are responsible.

The same rules of economics which apply to individuals also apply to countries and nation-states. Foremost among these is the rule that if you remain a debtor over a prolonged period of time, you lose control of your own destiny, and become subject to the whims of others.

The pendulum has now swung in China’s favor; in the 19th century and first half of the 20th century, China was the economic basket case. For the most part, Chinese have learned the importance of savings and not going into debt. Will the next generation of Chinese remember this lesson? Time will tell.

Americans need to face up to this unpleasant reality, and the sooner the better. The first step to recovery is to recognize that one is in trouble and needs to change current behavior.

The old ways just don’t work anymore.

Guest Post by Doug Rediker: More Caviar, Mr. Minister?

Between mouthfuls of canapes, business card exchanges and polite toasts, my prime take-aways from this past weekend's G7, IMF and World Bank meetings here in Washington were, first, how yesterday's poor third world countries have become, almost overnight, today's wealthy investment banking target clients, and second, the increased disconnect between the official and unofficial (private sector) events.

In particular, in dealing with Sovereign Wealth Funds (foreign government-controlled investment funds with assets approaching $3 trillion), this year, the divergence between the considered deliberations of the finance ministers and the goings-on in the simultaneous gatherings of the investment bankers, asset managers and their clients seemed even starker than usual.

The public face of these annual meetings is that of a group of august ministers presenting considered approaches to today's esoteric global financial issues. This year, the G7 ministers soberly pondered, among other things, how to address the rise of SWFs and the risks they may pose. Apparently, when Norway was the poster child for SWFs no one gave them a second thought. But with China, Russia and even Libya flush with cash - and looking to use it -- suddenly the issue takes on a more ominous tone.

Meanwhile, down the hall, the world's leading investment and finance professionals were wining, dining and pitching new investment ideas, structures and deals to the very same SWFs and government controlled entities. Guess which group was faster, more creative and more likely to come out on top? Not to mention more fun.

Ministers called for greater transparency, risk management and accountability. Some argued for reciprocity. The Russians -- with a straight face -- objected to anything that would restrict the free flow of capital. There was a general call for the IMF (looking to find a raison-d'etre) to create a code of conduct for SWFs (although we have no reason to believe that anyone would agree to live by it, nor would it be enforceable). Cautionary notes were raised about the need to balance knee-jerk protectionism, legitimate national security interests and the economic reality of the need for countries to attract investment. Hmmm, these are complicated matters, the ministers agreed -- let's consider these complex matters and revisit them at our next meeting.

While those considered discussions were ongoing, the real action was of a completely different nature and pace. DC hotels, meeting rooms and restaurants were overrun by investment bankers and financiers (all carrying thick binders filled with briefing notes for their back to back to back meetings) well into the night, frenetically cozying up to representatives of the newest targets on the international finance scene -- those very same SWFs. These funds are now the most important new potential clients for any investment banker worth his or her salt. In less than a decade, some of the same emerging-market governments that used to come to these meetings with hat in hand, are now being wined, dined and courted as never before. More caviar, Mr. Minister?

Courting SWFs makes perfect sense if you assume (as you should) that the financial world is motivated primarily (exclusively?) by financial considerations. Most players in the financial world take as a given Willie Sutton's famous reply when asked why he robbed banks -- 'because that's where the money is'. With tens, and in some cases hundreds, of billions of liquid capital to invest, SWFs are where the money is.

In noting this difference in approach, some have argued that governments have to take into account so many different interests, and so they must move at a more measured pace than financiers with a singular focus on financial returns. True. But, as SWFs and financial markets play an increasing role in capitals around the globe, there is a very real risk that governments may no longer have the luxury of the years that it usually takes to come to agreement on global trade talks. By the time governments have considered their options and hammered out consensus, the horse may well have long since fled the stable.

The rise of SWFs raise complicated issues that are beyond political. They are also financial -- with some very big numbers attached. While policy makers fret, teams of financial wizards are busily trying to address the question of how to spend all that money. It would be hard enough for governments to manage the issues that arise from newly emboldened states flush with revenues from oil and gas and holding our debt, without layering in the financial incentives that will entice every clever banker and deal maker to pitch their ideas to the SWFs -- generally without regard for the political implications they may raise. (For our own views, see here)

Individual governments, including that of the US, and multilateral institutions just aren't structured to keep pace with today's market dynamics, much less to keep ahead of them. International finance is increasingly important for governments from both developed and developing markets -- in ways that few would have foreseen, even a few years ago. This weekend's meetings demonstrated that these huge pools of capital are now getting the attention they rightly deserve -- from both the private (financial) and public (government) sectors. Let's see who's up to the task.

At the end of the event, the bankers I spoke with seemed pleased. In spite of complaints about too little sleep, too much champagne and the pesky issue of how to remove those caviar stains from Hermes ties, most felt that this was a small price to pay for a share of fees on several trillion dollars of SWF funds to invest. Dry cleaning bills aside, I wonder whether the official delegations came away feeling as satisfied.

--Doug Rediker

Doug Rediker is Co-Director, along with Heidi Crebo-Rediker, of the New America Foundation's newly launched Global Strategic Finance Initiative

October 23, 2007 On NPR Talking Subprime: What I Didn’t Get to Say

So I had a little cameo today on NPR’s On Point program titled The Mortgage Bailout Debate. On the air at the same time as me were Robert Shiller (Yale, author of Irrational Exuberance, you know the guy) and Robert Kuttner of The American Prospect. Two very smart guys. The tone of the discussion swayed from “How could those bankers have gotten paid millions of dollars only to get bailed out; how come the heads of the Wall Street firms haven’t lost their jobs?” to “There are some fundamental flaws in our regulatory system that need to be addressed.” Clearly a mix of populist rhetoric and economic substance, which I guess is necessary to both engage listeners and further the learning process. But I’d like to say what I would have liked to have said if I had more time to spar with the Bobs on-air.

First, let’s take a step back. What were some of the forces that gave rise to the subprime mess in the first place? Here is my own short list (in no particular order):

• Cheap debt a/k/a accomodative Fed policy
• Abundant investor liquidity
• Lack of sensible know-your-customer standards in mortgage origination
• CDO investors who didn’t do their homework and/or relied on rating agencies
• Bank investors who didn’t do their homework and understand the potential impact of off-balance sheet vehicles
• Rating agencies lack of experience in dealing with CDO credits of such complexity
• Poor accounting rule-making

Now if you look at this list and then say ‘How many of these problems did Wall Street create?”, my answer would be “precious few.” What Wall Street is exceptionally good at is taking advantage of the rules. They make sure they know the rules very, very well, better than any other constituency on the planet. Then they innovate, develop, structure and sell based upon delivering customers (be they issuers or investors) value in a form that enables them to make money. Risk sharing and mitigation. New asset classes for investment. Greater liquidity. These are all good things. Say what you want about Wall Street, but one thing I haven’t heard in the sea of criticisms of late are the words “illegal” or “fraud.” That’s because they did nothing wrong. They did what the current screwed-up regulatory construct (hello, Congress?) and the markets (hello, What me Worry? investors?) allowed them to do. So take a look in the mirror before throwing stones, all ye critics. Because odds are that you play a part in this crisis as well.

Mr. Kuttner made the comment that “SIVs were new and invented by Citigroup, I think.” Wrong. SIVs and their intended use has been around in a variety of forms for decades. Operating leases, sale/leasebacks, asset defeasance transactions - these are all geared around keeping assets off the balance sheet. Thing is, analysts (at least those who are sentient beings) know this, and good ones properly capitalize these off-balance sheet exposures effectively undo this accounting imagery in their models. Investors should be doing this as well, and if they don’t, too bad. Problem is when investors who are stewards of mutual funds, pension funds and other fiduciary vehicles do dumb things it is everyone who suffers. Not just Wall Street. Main Street.

Mr. Shiller made a point I agree with very strongly, that our fractured, decentralized regulatory infrastructure is woefully inadequate given the rapidly increasing scale, complexity and globalization of our financial markets. We do need a single set of rules for areas where market inefficiencies necessitate regulation, and one which both Bobs mentioned and which I agree with relates to underwriting standards. I am personally less concerned with the standards themselves than I am the “Know your customer” concept that already exists at retail brokerages both outside and inside Wall Street firms. This same concept needs to be enforced on mortgage originators, in order that customers will only be shown products that are appropriate given their income, job stability, etc., because it is clear that there were widespread abuses of people originating paper that never should have been written in the first place. And coordination of regulation between states and the Federal government is critical for clarity, which will make regulation easier and facilitate innovation.

So if you were to draw a picture of the problem with arrows and a big SIV in the middle, you’ve got loans in on the left, some good, some bad, into the SIV, and then CDO paper out. Retail investors need better protection on the left, in my opinion via know-your-customer and product appropriateness standards. CDO investors, many of whom relied on ratings agencies to make their purchases, need the confidence to be able to trust the integrity of the agencies and the quality of their analytical work. Right now, both issues are in question. That said, investors need to do their homework, over and above an implicit “seal of approval” from the rating agencies. And none of this addresses the accounting rules, which still enable off-balance sheet structures that defy both economics and logic. That is a post for another day.

I am glad these issues are being hashed out in public. I just wish that they were more dispassionate in their approach, leave the populist rhetoric to the side and to focus on the underlying problems that need to be fixed. Because there is a whole lot of fixing to do, and griping about Wall Street salaries is not going to get us there.