from Follow the Money

Unintended irony

February 25, 2009

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From a Tuesday Wall Street Journal story on Citigroup’s efforts to raise common equity:

Citigroup officials hope to persuade private investors that have bought preferred shares -- such as the Government of Singapore Investment Corp., Abu Dhabi Investment Authority and Kuwait Investment Authority -- to follow the government’s lead in converting some of those stakes into common stock, according to people familiar with the matter.

Emphasis added

There is a difference between a minority stake held the investment arm of a government that doesn’t regulate a bank or backstop the banks’ liabilities and a large stake held by a banks’ home government. But it is striking that none of the "private investors" mentioned in the Wall Street Journal are actually, well, private investors. Sovereign wealth funds are at best a hybrid.

China for example has made it clear that it hopes that the US will protect at least some of its investments from the risk of losses. China’s Vice Premier Wang Qishan told Hank Paulson:

"We hope the US side will . . . guarantee the safety of China’s assets and investments in the US"

He may have just been thinking of the Agencies ... but he also may have had a few of China’s other large stakes in mind. The classic response is that the only investment that is guaranteed by the full faith and credit of the United States government is a Treasury bond.

Yet, it increasingly looks like the US is inching toward severely diluting the common equity of a set of banks where sovereign funds have substantial stakes,* if not wiping out the existing equity entirely. That potentially -- as Larry Summers warned in a former life -- is a foreign policy issue. Summers pondered this topic at last years Davos session on sovereign funds:

[Suppose] the SWF of country A makes an investment in a major bank in country B. The bank gets in big trouble. Is there any control in the world that can assert, that with billions of dollars on the line, their head of state and foreign minister are not going to get involved in the negotiations?

I was never fully convinced highly visible sovereign stakes could be wiped out even if there was an economic case to do so, precisely because of the foreign policy spillovers, which is one of the reasons why I was never convinced sovereign funds should be thought of as just another private player in market. But this crisis keeps spinning in ways that put a lot of different presumptions to the test.

* These stakes often were structured, I think, as convertible bonds that automatically convert into common equity in the future. Most were not straight equity investments.

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