from Follow the Money

Wachovia/ Morgan Stanley/ CIC?

September 20, 2008

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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The reporting from Asia on Friday suggested limits to the CIC’s interest in Morgan Stanley. Restrictions on the ability of foreign banks to participate in the “TARP” (the current acronym for the bailout) might be another.

But the Wall Street Journal’s reporting (see Lucchetti, Enrich and Sidel) suggests that discussions are ongoing:

“Wall Street firm Morgan Stanley and Wachovia Corp. plowed ahead with merger talks Friday, even though announcement of the U.S. government’s crisis-fighting plan eased the pressure to race into a deal, people familiar with the matter said. Morgan Stanley’s board was expected over the weekend to discuss a deal, which may take an interesting twist. In one scenario being contemplated in New York, China Investment Corp. would take a significant stake in the combined company.In one scenario being contemplated in New York, China investment corp would take a significant stake in the combined company. … CIC’s interest might be contingent on Wachovia being able to offload some of its mortgage assets. So far, the CIC discussions has been preliminary and hasn’t been broached with Wachovia’s board.”

This sounds like a scenario that would need to be contemplated in Washington and Beijing as well as New York. Moving risky assets over to the books of the US taxpayer to create a “good bank” that appeals to the investment arm of China’s state council (an accurate, if undiplomatic, description of the CIC) would be a significant move – even in a week marked by a host of significant moves. The US government would effectively be a party in the deal.

I can see how say a voter in Ohio that – correctly – believes that China’s neo-mercantilist policy of accumulating foreign assets to hold its exchange rate down and support China’s export sector has contributed to the difficulties segments of US manufacturing have faced over the past few years might not look favorably on a deal that requires the taxpayer to assume downside risk and gives China’s government the upside. The US Congress has bulked at increasing China’s IMF quota because they haven’t wanted to reward China for intervening in the currency markets. The ideas that Morgan Stanley seems to be considering would seemingly require rather direct bit of US government assistance for a agency that helps to manage foreign assets that the US government doesn’t think China should be accumulating in the first place.

Yes, a CIC investment could help the banks raise needed equity capital and thus offers a potential alternative to an even bigger investment by US taxpayers. But a large CIC stake would also start to raise issues about who should provide the government backstop for the combined institution: China or the US? Bailing out US banks is one thing. Bailout out a Chinese-government-owned US bank is another.

That question hasn’t come up in the past because governments generally haven’t owned financial institutions with large operations outside their home markets. Singapore I guess is a partial exception; Temasek has large stakes in a lot of financial institutions. But it is at least worth starting to consider who has responsibility for such an institution in the new world of state capitalism.

Finally, it is a little puzzling how China’s government could find Agencies too risky without a US Treasury guarantee (Chinese representatives apparently told the US that they expected the US to "do whatever is necessary" to protect the Agencies) and simultaneously find Wachovia/Morgan Stanley’s book attractive. It presumably has rather more risk than most Agency bonds. On the other hand, it probably is a stretch to assume that China has a coordinated external investment policy now that management of its reserves has effectively been split between two (or more) rival institutions …

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