McKinsey Executive Roundtable Series in International Economics: Sovereign Wealth Funds on the Rise: Should We Worry?

This meeting is part of the McKinsey Executive Roundtable Series in International Economics, presented by the Maurice R. Greenberg Center for Geoeconomic Studies and the Corporate Program.

ALAN MURRAY:  Can we -- could we go ahead and get started please?  Make your way to your seats.  I'm Alan Murray with The Wall Street Journal.  We have -- welcome to the Council on Foreign Relations.  Remember, everyone please turn off your Blackberries, cell phones, et cetera, and I'd like to remind everybody that today's session is an on-the-record session, so you may quote what you hear here this morning. 

I think the size of the turnout at this early hour is an indication that we're dealing with a very hot topic this morning.  I just got back a couple weeks ago from the World Economic Forum in Davos and my experience over the years is every year there's sort of one topic that captures people's imagination and becomes the issue that is most talked about each year.  In the '90s it was technology.  From 2001 to 2006, it tended to focus on U.S. foreign policy, militarism, interventionism.  Last year private equity was the hot topic of conversation, not quite so hot this year.  But this year it was sovereign wealth funds -- a great deal of attention -- a great deal of discussion -- these giant pools of government-controlled capital now approaching $3 trillion by at least one estimate, headed towards something more like $12 trillion in the not-too-distant future. 

We've got a great panel this morning to discuss the issues involved.  Stuart Eizenstat, who's a partner and head of the international trade practice at Covington and Burling; and then Mohamed El-Barion (sic) who's the co-CEO and -- Mohamed El-Erian, excuse me -- co-CEO and co-chief investment officer at PIMCO; Simon Johnson from the IMF; and Dan Tarullo from Georgetown University Law Center.  You have all their bios in your information.  And I'm going to start with Mohamed to ask the central question, I think, in this controversy.  U.S. officials, IMF officials spent decades going around the world preaching the virtues of privatization, of getting enterprise out of the hands of government.  Now we have this huge trend of sovereign wealth funds buying large stakes in private businesses.  Is it something that we should be worried about?

MOHAMED EL-ERIAN:  You know, to answer that question you have to put it into context.  The same people who are worried now about government investments are those who were also advocating the free flow of capital and are now worried about the consequences of the free flow of capital.  You should worry about it in the sense that it indicates that the world is changing very quickly, that wealth has shifted, and that the system that we have right now is not well suited to deal with these new flows.  You shouldn't worry about it because it is recapitalizing the sectors that need most capital right now. 

I noted earlier just think what the U.S. financial sector would look like today if you hadn't had $59 billion of pure capital flowing to it over the last seven months from sovereign wealth funds.  It would be a very different outlook for the U.S. economy.  It would be a very different outlook for the global economy.  So I think the key issue is not just the sovereign wealth funds.  It is that this is part of a much larger realignment of the global economy, and the infrastructure, be it in the public sector or be it in the private sector, is just catching up today to the realities that have already occurred. 

MURRAY:  Dan Tarullo, listening to Mohamed doesn't sound like there's too much reason to be worried.  And I have to say I asked a number of CEOs this question -- if you had a choice between an investment from a hedge fund, from CalPERS -- the California Public Employees Retirement System -- or from a sovereign wealth fund which one would you prefer, and everyone I asked the question hands down said sovereign wealth fund.  So given that, what is it that we're concerned about?

DANIEL TARULLO:  Well, I think two things, Alan.  First, to elaborate a bit on what Mohamed said, I think it's not just the amount of money in the sense that the center of economic power is sort of shifting around the world.  I think it's also the fact that these investments into U.S. financial institutions come in the wake of a massive failure of risk regulation by our own -- risk management by our own financial institutions, a substantial failure of supervision by our bank and other financial regulatory agencies.  So it kind of accentuates the fact that money is shifting overseas, economic growth is shifting overseas, and at the same time our model, which as you indicated we kind of proselytized for a long time, seems itself a little bit on the shaky side.  So when you talk about Davos, well, because, Davos is always the issue du jour -- (inaudible) -- but there is this sense that there's a lot of symbolism as well as substance.

Now, in terms of what the concern might be, you know, I'm not surprised that a CEO of a big company, or for that matter particularly a financial institution but maybe any company, would be rather more comfortable with an investment that at least promises to be a little bit longer time and a little bit less activist than maybe a hedge fund would be in looking for immediate results.  I think the concerns that exist in Washington and maybe in some other quarters as well focus on what might happen over the medium to long term.  There -- this -- these are government-owned funds which differ enormously among themselves -- and one needs to be careful to differentiate them -- but at least a number of these funds are sourced in countries that do have a quite different view of how economic development should proceed, and in at least some cases have some sense of economic rivalry with the United States or with Europe or with the West generally.  So it's the prospect of investments made and perhaps managed not always for commercial or economic reasons and perhaps sometimes with a medium to long-term strategic interest in mind which raises the concerns.  And I want to emphasize for me that's -- it's a very different thing to say that it's a medium to long-term concern about what may happen as opposed to what's happened to date.

MURRAY:  Are you making a distinction between the sovereign wealth funds in Abu Dhabi or Dubai which have been around for a long time as opposed to, say, sovereign wealth funds in Russia, China?  Should they be treated differently?

TARULLO:  Conceivably.  I mean, as -- when we were in the other room before we started the program Mohamed was talking about the fact that the funds that have been around a long time are ones that are known to market actors.  It's not as if they couldn't change but I do think, Alan, that the newer funds from countries which are taking themselves -- which are themselves trying to figure out what their policies are going to be now that they have all this wealth at least warrants a little closer scrutiny.

MURRAY:  Stuart Eizenstat, you're testifying before Congress tomorrow.  Members of the Council on Foreign Relations love the notion that they may get the inside skinny a day before everybody else.  Why don't you tell them what you're going to say?  (Laughter.)

STUART EIZENSTAT:  Well, I mean, the first thing I'm going to say is that at the broadest level there is a concern about sovereign wealth funds but for a different reason than official Washington says.  The reason is that the growth of sovereign wealth funds in the last several years is a reflection of our dependence on foreign oil, of our current account deficit, and that in fact this is a way of recycling our own petrodollars and making sure they come back to the United States to create jobs rather than go elsewhere.  That's the basic problem. 

Now, the problem that Washington has is the following.  First, they don't understand the fact that sovereign wealth funds have a long history of responsible long-term investment.  They're generally passive investors which is one of the reasons why your -- people would rather have sovereign wealth funds because they don't bother anybody, which is not necessarily all good.  They also do not generally have a political agenda.  They're after a bottom line profit.  And interestingly, in the initial round of recapitalizations that Mohamed mentioned there was a very benign political reaction in Washington because they understood that the need to recapitalize our financial institutions was really critical.  Even in the national security process there has not been generally a reaction. 

Just give you a couple of real quick examples.  When Kuwait bought Barneys in summer of 2007 that's hardly a national security issue.  It didn't even go through the interagency SIFIUS process.  If you're under 10 percent and these sovereign wealth funds are structuring their deals to stay under the 10 percent control test, you don't go through the SIFIUS process.  And even those most recently that did -- for example, the sale of IBM's PC division to Lenovo, a partly owned -- state-owned Chinese company or the sale of GE Plastics to SABIC, the Saudi fund -- raised no hackles because there were no real security nexuses.   If that's the case what is Washington worried about?  And this worry comes not, I want to stress, from just economic protections.  Chris Cox with the SEC, Bob Kimmitt, Clay Lowery, Ted Truman at the Peterson Institute have all mentioned the following concerns from a policy perspective.  Number one is transparency -- how are they managed, do they have a commercial purpose, do they have a political purpose instead.  Second, there is the question of technology leakage.  A Chinese investment fund -- is there going to be leakage back to the People's Liberation Army for sensitive technology? 

Chris Cox has laid out a number of other concerns.  He says that when you have a government playing this role they're both a market player and a referee -- that you have potentials for corruption in the use of the funds, and that the key therefore is transparency and openness.  Now, my basic message tomorrow will be you just -- Congress legislated in a bipartisan fashion after Dubai ports and what you said was we're going to do a responsible piece of legislation, the president signs it, it is a little more transparent process.  It's essentially the old SIFIUS process -- nothing dramatic.  Don't overreact and try to go back again and re-amend it on sovereign wealth funds.  Wait for the IMF best practices guidelines, which will be out in April.  Wait for the OECD best practices guidelines for host countries, which will be out in March, and let the SIFIUS process you've just recreated work on a deal-by-deal basis.  And then if you see that there are problems, fine.  But let the interagency process work and let the IMF and OECD processes work.

MURRAY:  Well, let's ask Simon then about the IMF guidelines.  I mean, is this a problem?  Is this as much a political issue in other countries as it is here in the United States, and do you think the IMF will be able to come up with a set of guidelines that'll put it to rest?

SIMON JOHNSON:  Well, I think this is a global issue and this is an issue that concerns many of our 185 member governments who are on different sides of this equation, and I think as Mohamed has been saying there's scope for mutual reassurance here because many of these funds are long established, have a strong track record, and have been very responsible over the years.  So I think there's interest on all sides.  I would like to clarify that the process that's going on right now is one in which the IMF is actively engaged in a dialogue with the large sovereign wealth funds, and that's been a very constructive dialogue so far.  I think there's lots of interest on the part of these funds in talking about the issues and in examining how they can be treated in a way that's fair and equitable across this global capital market.  It is a dialogue.  It will lead, I think, to something you may call best practices or perhaps good practices because I think there may be one -- more than one way to organize various parts of the activities that is sensible and respectable.  I don't think the full process will come to an end in April.  I think it's going to be ongoing.  There'll be a reporting out at the time of the spring meetings.  It's going to continue, I think, beyond that.  I can't speak to the OECD but I think we're -- we -- the IMF and the OECD are on similar timeframes in that regard.

MURRAY:  Simon, is there good reason for treating the sovereign wealth funds separately from other large pools of capital, private equity hedge funds?  Is there something so distinct about them that they require separate codes of conduct, et cetera?

JOHNSON:  I'd like to distinguish, Alan, between the stocks issue and the flows issue, and I think you've heard the panelists so far talk about this.  In terms of stocks -- in terms of the amount of capital that's out there and how it operates -- I think there's a very strong case for all large pools of capital receiving similar kinds of treatment and having similar sorts of requirements.  Different ownership structures, of course, but in terms of transparency and in terms of information, in terms of the voluntary nature of best practices, the kinds of discussion that had been around private equity, for example, in the U.K. strike us a being quite sensible and acceptable more broadly. 

On the stock side, I think, you know, should be an even playing field.  On the flow side, however -- and I think it is the flow -- you yourself mentioned key numbers at the beginning.  The stock is about 2 (trillion dollars) to 3 trillion (dollars) -- that's the  market estimate; don't see any reason to disagree with that.  That's not a large amount of money relative to global capital markets or global wealth.  What is worrying is the flows.  Remember this money comes from current account imbalances around the world.  It comes from the fact some countries have large current account surpluses that are not, as far as we can see, going down.  And if this process continues for another five years then you have a much larger amount of capital.  So we're trying to say we'll talk about the stocks, we'll deal -- we'll engage in this process.  That's the constructive process of dialogue around the stocks and how they're managed.  What we should really not lose sight of is the flows, and the current account imbalances need to be addressed.  That's an old problem.  Sorry if it's a boring problem but it's a -- it's the fundamental issue here.

MURRAY:  Yeah.  No, not at all and it's not just -- you mentioned, Stuart, petrodollars but it's not just petrodollars obviously.  You have these large Asian nations that are accumulating huge surpluses and much of that is being channeled through sovereign wealth funds as well.

EIZENSTAT:  But Alan, there is a difference, again, between private equity hedge funds and sovereign wealth funds.  For example, with sovereign wealth funds, there are some like Temasek, which is the Singapore sovereign wealth fund, that really are run completely on a commercial basis.  They do not get any government subsidies in general, nor do they get subsidies on individual deals.  But some of these sovereign wealth funds do subsidize the deal so that if you have a U.S. company competing to purchase a U.S. asset with a sovereign wealth fund and the sovereign wealth fund's not transparent, it is very possible that that sovereign wealth fund may be subsidizing the very transaction --

MURRAY:  Which in particular?

EIZENSTAT:  -- unfair competition.  Well, for example, the Chinese Investment Corporation -- they provide subsidized financing for a lot of their transactions.  If they're competing against a U.S. company trying to acquire the same U.S. asset is there a level playing field, and that's one of the concerns that's also been discussed.  But the second concern and a broader concern is is the sovereign wealth fund, as in the case of Temasek, purely run on a commercial basis -- commercial managers, they publish reports, they have annual reports by Temasek -- or is it a fund that's opaque, that may be controlled by a government ministry?  Take an example -- Gazprom.  If Gazprom wanted to purchase a pipeline in the United States and Gazprom is directly not only state owned but it's controlled by a government ministry, that raises issues.  It raises subsidy issues.  It raises issues of whether they're being done on a commercial as opposed to a political basis, and whether they have political issues.

MURRAY:  I assume that's what the code of conduct will get at.

JOHNSON:  Good practices or best practices is what we're calling it. 

MURRAY:  Sorry.

JOHNSON:  Alan, I think the practices are still being discussed and I don't want to jump ahead of that.  I think every country in the world has, you know, some legitimate political concerns about national security, perhaps about technology, and I think those can be addressed appropriately through national legislation.  I think -- and I don't think anybody has a problem with that.  I think the view of the IMF is it's to everybody's advantage to keep an open trading system -- open capital flows system.  I think that the guidelines and the best practices or the good practices are going to be actually learning from the sovereign wealth funds that have been around for a long time, that have earned Mohamed's respect, and that work closely with the market, and that are well regarded by the market.  And I think learning how they manage that over a long period -- I mean, 30 years -- actually some of them go back almost 50 years -- how have they done that and how can the relatively new sovereign wealth funds which have got a lot of the attention -- disproportionate amount of the attention perhaps -- how can they learn from that experience and share knowledge among themselves in a way that's acceptable.

MURRAY:  Yeah.  Mohamed, we've been talking about transparency.  Is it pretty clear to you who the good actors are and who the questionable actors are in this world?

EL-ERIAN:  I think the one fund that's ahead of everybody else is Norway.  They publish on a quarterly basis information.  They have a press conference on a quarterly basis.  Key issue is transparency but not with respect to holdings as much as process.  People should have clarity as to what the governance structure is -- as to what your objectives are -- what is the investment process -- what is risk management.  That is really what you need, and I say this because in my previous job at Harvard Management this is what we had to convey to the world as to what we are doing. 

Think of why the revealed preference of the private sector -- you mentioned the CEOs you talked to -- is to welcome money from sovereign wealth funds.  Part of it may be that it's passive, and if it is passive then we shouldn't worry about political interference.  But I don't think that's the only reason.  I think the most important reason is this is privileged capital.  This is long-term capital investing over a very long-term horizon.  That, for a CEO, is critical because that means that you're not going to see flows of capital that are not linked to what's happening to you but linked to the outside.  Other capital which is not long term, which is subject to redemption, behaves in a way that's very different.  So the critical thing here is on the one hand the sovereign wealth funds, now that they're systemically important, have an obligation to the system to be more transparent about their process.  On the other hand, we have to be very concerned that we do not discourage the best form of capital in the system.

MURRAY:  Interesting comment about Norway, which, as you say, is the most transparent of the sovereign wealth funds.  But my understanding is it's also probably, in some ways, the most politically explicit of the sovereign wealth funds.  It's interested in socially responsible investment, environmental -- it's probably not unlike the Harvard endowment in that regard.  (Laughter.)

But does that bother you at all that they have clearly stated political goals?

EL-ERIAN:  You know, in terms of global capital -- and Simon referred to it -- this is now less -- add all the sovereign wealth funds together; they're less than 3 percent of global capital.  And within that, certain sovereign wealth funds focus on certain issues.

You mentioned Norway, and they're very clear about their negative list.  And they're very activist.  In fact, there was a big debate with Wal-Mart, a public debate with Wal-Mart a few years ago.  And I think that we have to see it as a pool of capital with different people focusing.

What they're also clear about is that there's a limit to how big they can get in any single company.  And that's what gives people comfort is that they have a self-imposed limit, that they will not get larger than "x" percent of the capital of the company they're investing in.

MURRAY:  So, Dan, seven, eight years ago, when this country went through a very brief period of surpluses, there was a debate about whether the Social Security trust fund might be invested directly.  And a lot of people -- and the administration came to the conclusion, "No, we can't do that.  We can't trust the Social Security fund to be invested in stocks.  That would be a bad thing."

If we can't trust the Social Security fund to be invested in stocks, why would it be all right for government-controlled funds in the rest of the world to be invested --

TARULLO:  Well, Alan, I think -- if you recall the debate, there were different positions that converged in the same outcome.  You recall that Greenspan's objection was principally a concern that government employees or officials would somehow be involved in picking stocks, which he was very cherry of for a lot of the reasons that Stuart and I have been mentioning.

Then there was a concern that came from a slightly different quarter, which is that the volatility of the stock market might disadvantage people who are retiring at a particular moment in time, which had little or nothing to do with the issue of government ownership or government selection.

I think -- I mean, you mentioned the Norway fund.  These things can get politicized even when the actors are behaving just as a hedge fund would.  The Norwegian fund shorted Icelandic sovereign bonds, which elicited quite a bit of unhappiness in Iceland, which was conveyed to officials in Oslo, and thereby created a political issue out of what -- out of an action which, if it had been done by one of the funds based out here in Greenwich, everybody would have said, "Hey, that's the way hedge funds operate."  They saw an opportunity here.

So I think you see that the --

MURRAY:  Although, I mean, Citigroup has a similar problem in Germany, right?  You don't have to be a government to be sensitive to those kinds of pressures.

TARULLO:  No, you don't.  But you probably -- your demarches being what they are and diplomatic relations being what they are, you're probably going to get them more directly, and it's going to turn into a political debate.  I mean, look, let me say a couple of things here.  I think it feels to me as though this is something where the Congress and policymakers generally are groping.  And it's probably in everybody's interest that they continue to grope for a while rather than to do something.  (Laughter.)

But that is not to say that something may be not to be done eventually.  And I actually have a bit of concern that what may be done ultimately might not be particularly productive, even if it looks like it's activist.  For example, Stuart was mentioning CFIUS.  Do we really -- if we have concerns about this, do we really want all the concerns shoved into a box where it's all about national security?

A lot of the concerns you hear articulated are not national security even in a somewhat fulsome sense of the term, but rather questions about distortions of markets and of market decision-making and of economic advantage.  If a foreign sovereign wealth fund takes a sizable position in a U.S. financial institution and, over a period of time, there is a sense in the management of the financial institution that locating a certain function of that institution in the investing country might just be a good thing for investor relations, that doesn't feel like a national security issue, not in any sense in which I understand the term.  And maybe you don't worry about it at all.

But I guarantee you, senators from the state of New York will be concerned if that means the jobs that would have been here are going to be abroad instead.  I don't know that that's the sort of thing that you can do with CFIUS.

MURRAY:  Well, so how do you do it?

TARULLO:  It seems to me that's where, I mean, the problem is.  One alternative that has been talked about somewhat is identifying those industries in which particular concerns might exist.

Look, we can -- I guess we could come up with a hypothetical by which people would be worried about sovereign wealth fund ownership of a large retailer in the United States.  I myself would have trouble coming up with that hypothetical.  Somebody might.

MURRAY:  But you're at least raising the --

TARULLO:  Well, wait a second.  But we have industries already in which foreign ownership is monitored and, to some degree, limited -- the banking sector, telecommunications, certain energy, certain parts of the energy sector, aviation, defense-related industries.

There's a reason why those industries have already been tagged with a particular attention to foreign -- not necessarily foreign governmental -- in some cases yes, in some no -- foreign ownership.  And it may be that part of the answer here -- and my guess is this is not a silver bullet kind of response or answer -- but part of the answer may be saying, "Have the kind of screening, scrutiny and oversight that the agencies in question do.  Take account of these sorts of things."

The Fed already looks at investments in bank holding companies and banks for certain set of purposes.  It might be an easier, less confrontational and actually more sensible thing for the Fed to be charged with looking at an additional set of considerations.

MURRAY:  Stuart.

EIZENSTAT:  I think we have to put this in context.  First of all, if a sovereign wealth fund buys a public U.S. company, that company is itself already going to be subject to disclosure.  The SEC requires it.  So you take away a lot of the concern about opaqueness simply because the asset they're purchasing is itself going to be public.

Second, the vast majority thus far of sovereign wealth investments don't even touch the CFIUS process -- that's the Committee on Foreign Investment in the U.S. interagency process -- because you don't get to CFIUS unless you hit 10 percent interest.  And they've structured many of the deals, certainly in financial institutions, to stay under that.

Second, there has to be a national security nexus.  Now, right now, as we speak, Treasury is coming up with what will be absolutely critical regulations on the new financial services bill, the FINSA bill that passed in a bipartisan way, and revised the CFIUS process.  And they're going to look at some critical issues.  Number one, how do you define control?  Number two, what is national security?  We've never defined that.  It's always been a case-by-case basis.  Three, if you invest in something called critical infrastructure, does that trigger a national security concern?

Now, under the Patriot Act passed after 9/11, about 25 percent of the U.S. economy is considered to be critical infrastructure, refineries and so forth, things that actually are not critical -- they're critical perhaps from a deterrence standpoint, not from an economic standpoint.

And it's very important that the Treasury, as they define critical infrastructure, not take the broadest definition, which could cover 25 percent of the whole U.S. economy -- and I don't think they will -- but narrowly define that so that it is really things that touch on -- high-tech technology, missile defense, government contract-related things.

If they define it that way, then the number of deals that even go through the CFIUS process will be quite limited.  And when you combine the best practices which we hope will come out with the fact that most deals won't go through CFIUS, it will be a fairly narrow band of deals that will actually be of concern.

And those, I think -- maybe Dan disagrees with this -- I'm prepared to leave that to the interagency process.  I'd rather have the executive branch, in a closed process, look at those rather than get Congress engaged either on a deal-by-deal basis or trying to amend an act that they just amended only a few months ago.

MURRAY:  But Stuart, isn't the question really, to some degree, whether you would want any expansion of oversight to take into account some of these concerns about economic impact to go through a national security process?  I mean, I thought traditionally you and I have been on the same side of the CFIUS process, which is to say, keep it about national security; don't make it about everything.

I think there's a risk that if we say, "Well, to the degree there's a problem here, deal with it in the CFIUS process," that you kind of open the door to CFIUS, which is essentially a military/security-driven kind of process, being about the entire economy.

EIZENSTAT:  I agree 100 percent.  In fact, what I'm, again, hoping is that when Treasury does these regulations, they will really limit the things they look at to genuine national security issues, not to economic security issues.

MURRAY:  But then the outstanding question is going to be the kind of hypothetical that I posed a few minutes ago, something that worries people, and if so, where is it going to be addressed?

Mohamed, let me -- we're focusing here on the potential problems.  But you, at the outset, raised the point that in this country sovereign wealth funds came to our attention not as a problem but as a solution.  We had a problem, and they made large investments in the big New York financial firms.  The problems could have been much worse had they not, correct?

EL-ERIAN:  Yeah.  I mean, your newspaper characterized it as "The world comes to the rescue of Wall Street."  The Financial Times characterized it as a bailout.  The Economist was interesting that week, because they characterized it very differently.  The image was military helicopters coming in, dropping money -- (laughter).  And the title, which I brought with me, was "The Invasion of the Sovereign Wealth Funds."

So I think it's important how we view it, because there are three distinct contexts.  One is national security.  And we have CFIUS as an instrument for that.  Second is the political context and the discomfort that people have about foreign ownership.  And that's true not only in the United States.  That's true anywhere in the world.

But the third context -- for me it's a critical one -- is that the reason why we are on the stage is because the United States in particular has gone from a creditor regime to a debtor regime, and it has done it for so long, as Simon has pointed out, in terms of current account deficit that the stocks have accumulated in the rest of the world.

And what we're dealing with here is now the redeployment of wealth that has been part of the fit in regimes around the world.  And it's critical that we deal with these national security issues by themselves, that we address the political issues, but also we look at the economic issues and ask, "What is the counterfactual?  What happens if you interrupt the recycling of this wealth?  What happens if you force it through other channels?"

It's not that the issues go away.  In fact, you can argue that the issues will become even larger.  And I think it's important to have this type of debate that distinguishes between the various elements so that you make sure that you don't end up in an even worse state of the world, because what you're dealing with is a fundamental change in the global economy.

When the superpower goes from being a creditor to a debtor, as shown by the current account deficits, you have a number of consequences or repercussions that you have to deal with.  And that's just one of them, but there are many more out there.

MURRAY:  I want to open it up to the audience in just a minute.  But Simon, let me just ask you, when we are talking about the concerns, most of the concerns do seem to be hypothetical.  I don't hear people pointing to things which have happened in the recent past that are of concern, but more about what could happen if governments became more directly involved in the allocation of capital.

Is there -- as you're thinking about best practices, is there reason to worry that as the stocks build up, you have a change in regime or a change in approach that then suddenly becomes a problem because one of these sovereign wealth funds owns such a huge portion of capital assets around the world?

JOHNSON:  I think we're some distance from that particular problem.  But I think there's two issues that strike me from this very reasonable discussion.  The first is protectionism.  I think it's the -- you know, while I don't disagree with any of the reasonable points being made, and as I said before, every country has a right to set up its own legislative framework to receive investment, I think Mohamed is warning not just the United States but everybody who's receiving capital -- of course, you don't have to be a debtor nation.  There's gross capital flows going in and out everywhere around the world.

It's very important -- we spend a lot of time thinking about current account protectionism or worrying about tariffs, and we had a good process in dealing with that.  I think we have to think much harder about capital accounts.  What is reasonable openness on a capital account?  To whom?  On what basis?  It's really very important if we're going to be able to sustain a global growth.

The second thing I'm going to worry about -- we are worried about, obviously, very much -- our top priority right now is highly leveraged institutions.  We think, building on what Mohamed said, again, we think that these sovereign wealth funds have not -- do not use a lot of leverage.

One consequence you need to think through is if you force them to go certain ways, there's other ways.  If you force more of their capital to go through certain channels, perhaps you're encouraging more leveraged investment, some of the proposals that are out there.  I don't know if that's a very good idea.

I think, you know, what we're worried about right now is sorting out some of the problems that have come -- the risk management, as Dan said earlier, in highly leveraged context.  And the sovereign wealth funds have been helpful precisely because they have a lot of capital; they're not subject to the same problems, all one big Harvard endowment, (if you ?) like to think of it, run by Mohamed.  So that's exactly what you need in the capital markets is stability in periods like this.  How that's going to change over time, Alan, I think remains to be seen.

MURRAY:  Right here.  Please identify yourself before asking the question.

QUESTIONER:  Gordon Bell.  Good morning.  I'm a ClearBridge adviser to Legg Mason Company.

And for the two gentlemen, Alan and Stuart, if you don't think it's a national security issue that the Kuwaitis bought Barney's, you've not been here during fashion week.  (Laughter.)

Good to see you again, Mohamed.  We haven't seen each other since the Harvard days.

The question to open is about a specific situation, and I'll just go through it very briefly.  Dow Chemical sells about 50 percent of its ethylene chemical business to the Kuwaitis for $9.5 billion.  That's not a problem right now.  The deal is going to close at the end of '08, which is actually an extraordinarily long term to close.

But down the road, when there's scarcity, there could be issues.  Down the road, when pricing changes occur, and perhaps Dow gets preferential pricing for its feedstock petrochemicals, there might be issues.

The question I'm driving toward:  What mechanisms are going to be in place, should be in place, so that the government, CFIUS, some group, has the ability to come back and revisit an issue and have a discussion that yields a good result?  I'll leave it there.  Thank you.

MURRAY:  Who wants to take that on?  There could also be a change in the Kuwaiti government as well.

EIZENSTAT:  Well, first of all, the CFIUS process has the capacity to relook at deals that they've approved, because there are conditions.  There are annual reporting requirements.  There are certain conditions that have to be met as a part of the process of being approved by CFIUS.  And if there's a violation of those, that is something that the interagency process can look at.  You'll have congressional oversight as well.

There's a deal now that's pending that will really be, I think, a significant test of the CFIUS process.  This is the Huawei/Bain Capital acquisition of 3Com.  This is in the CFIUS process now.  It's a high-tech issue, the question of whether Huawei has connections to the Chinese government, although it's nominally a private company.  Those are the kinds of issues that can be revisited even if there's an approval.  So it's not as if the process just wipes its hands of anything.

There's a second issue which we haven't discussed that also is getting congressional attention, and I hope will not make its way into any kind of legislative effort, and that is the issue of reciprocity.  That is, the question is, should we allow sovereign wealth funds or state-owned enterprises to acquire U.S. assets if U.S. companies couldn't acquire a similar asset in those countries?

I mean, when you talk about economic protectionism, we've talked about the U.S.  The fact is, France has got decrees setting even for EU investments, some 12 sectors.  Russia is developing the same.  China is now setting a whole set of sectors off.  So the question is on reciprocity.

Now, Bob Kimmitt, on behalf of the Treasury -- and I think it's the right position -- has basically said reciprocity should not be a factor in deciding whether we take a sovereign wealth investment even from a country that wouldn't allow us to invest, because that's their disadvantage.  We shouldn't disadvantage ourselves because they're closing their market.

But you can see the political impetus to say, "Well, what's fair for the goose is fair for the gander.  If they don't let us in, why should we let it?"  And that's an instinct that has to be opposed or we'll really go down a very treacherous road.

MURRAY:  Yes?

QUESTIONER:  John Beatty (sp) from UBS.  There's been a lot of discussion recently about financial stability and reforming the international financial framework.  The recent Asian financial crisis, by way of example, was exacerbated by short-term capital outflows from the system.  Given that sovereign wealth funds are long-term investors, as well as the fact that they are affiliated with sovereign governments, should we consider them or incorporate them into the international financial stability framework that's currently being discussed?

MURRAY:  Simon?

JOHNSON:  Well, I think this is a very good question.  I think that you're absolutely right to suggest that when you think about financial stability, you should think outside the G7, outside the industrial countries.  It's very much about interactions between lots of countries, including between industrial countries and emerging markets and developing countries.  And it's a multilateral flow of capital.  So I think it's important -- and there's ongoing work which I think you're referring to within the Financial Stability Forum, for example, involving the IMF, but also more broadly around the BIS -- people are looking at codes, looking at standards and so on and so forth. 

I think it's very important that be an inclusive process.  I think you need a table -- a very, very big table -- with everybody sitting there.  I wouldn't say it's just governments.  I think private sector has to be there from different places as well.  And you know, I think, as Dan said, in other countries how they draw the line between the state and the private is different, and that's something you need to look at and decide -- everybody needs to decide if they're comfortable with each other on that basis.

But I think you're absolutely right.  I think -- you need to -- the only way to think about financial stability is in global terms, and that has to involve the people who have the capital as well as the people who are receiving the capital, and that's got to be emerging markets and the industrial countries.  That's the only sensible way to go forward I think.

EL-ERIAN:  Let me add something, because I thought you were going somewhere different with your question.   Some 20 years ago when I was at the IMF and we decided that we really needed to talk to market participants to figure out what was going on, we came up to New York -- which was very strange at the time; now it's done regularly -- and we met with some banks, et cetera, in the midst of the Latin American crisis.  And we asked them, "What's the first thing you did when you heard that Mexico was having problems?"  And they told us, "We immediately reduced our lines to Chile and Colombia. 

For us as economists, that was absurd because Chile and Colombia were doing so well.  In fact they avoided a restructuring when virtually everybody else restructured in the '80s.  But for them, that was a very natural reaction, which is to reduce risk throughout the process. 

Now, compare that to what happens when you're managing a pool of long-term capital if you don't have redemptions, you know exactly what your pay-out structure is.  And these events, like the Asian crisis, et cetera, are not selling events but they're buying events.  Why?  Because you're confident that your capital is not going to go away. 

So in addition to thinking about the implication and the (regulation ?), it's important also to recognize the mindset that has to govern different pools of capital as the world goes through this nonlinear process.  And that is why you got the reaction of $70 billion going into the U.S. financial sector at a time when others are reducing their exposure and we're talking about a credit crunch.

Now, the critical assumption here is that this large pool of patient capital acts in a commercial way, and that's the critical assumption, and that's where the spotlight has to be put to make sure that you have enough transparency about the process to get that commercial reaction.

MURRAY:  Way in the back.

QUESTIONER:  Elias Caroces (sp), Citigroup.  Where do you see the status of the dollar as a reserve currency for these funds?  And do you see a risk of an unwieldy exit from the dollar spurred on by one of them?

MURRAY:  And we are on the record.  (Laughter.)

JOHNSON:  I'm always on the record -- (inaudible, laughter.)

We think that the adjustment process that's happened since the summer has been encouraging and oddly, with regard to the depreciation of the dollar -- the dollar has depreciated more than 20 percent, as you know, since 2002, and this happened in the context of falling long-term interest rates in the U.S.  So that is very good news. 

We still think the dollar is somewhat overvalued, meaning over a five-year horizon, which is the position -- the outlook we have.  We think that it will tend to depreciate in order to bring the current account closer to what regard as a sustainable level.  So that's the good news.

The less good news is this adjustment process has been asymmetric.  And again, I'm going back to the flows, you see.  It's all about the flows to us.  The stocks are important -- we discuss them as an outcome of the flows, and the problem is that there are certain countries that have relatively inflexible exchange rates that have not -- these exchanges have not moved in the direction we would regard as being towards that that would sustain the current accounts at a reasonable level.  And I'm talking about the lack of appreciation in certain countries.  So for example, we regard -- we continue to regard China's renminbi as substantially or considerably undervalued.  So over a five-year period, we think it should be appreciating in real effective terms to bring China's current account surplus down -- down considerably. 

Now, that part of the process has not yet happened.  The Chinese authorities are trying to make steps in this direction.  We're encouraging them.  Other people are encouraging them.  It's not a zero sum game at all.  It's a very important process for sustaining global growth. 

I think that's the context in which you should -- it's about exchange rate adjustments.  I think the sovereign wealth funds in that context are, as Mohamed has emphasized, long-term players, long-term players who have -- who want to have diversified global portfolios.  And I think the chances that -- there are serious financial risks out there, which we're talking about very explicitly and which you saw, for example, reflected in the G7 communique.  Those risks are mostly about highly leveraged institutions and the way in which risk is managed or not managed.  That's not about sovereign wealth funds.  Sovereign wealth funds have played a key stabilizing role in the past six months with regard to recapitalizing the bank system, and we should recognize that.

MURRAY:  But Simon, just to follow up on that for a second, putting the petrodollar funds aside, are sovereign wealth funds to some degree a creation of currency manipulation in your view?

JOHNSON:  I think we should regard -- I don't like this, "Well, there are these kinds of funds or that kind of funds."  I think we put them all together. 

You know, we have an open global trading system that has some very well specified rules.  The rules are always being adjusted both at the global level and at the national level.  That's fine.  I think countries have come together and traded on a fair basis subject to these rules.  There are processes for appealing this particular kind of export or that kind of import restriction, as you know.  And I think that in that context, it's important that there be sufficient exchange rate flexibility. 

Now, some countries find it easier to have exchange rate flexibility because of the nature of their economies.  Some countries find it a little bit harder.  We at the IMF have been encouraging very publicly certain countries to encourage, in this context, an appreciation, for example, of the Chinese renminbi. 

But it's not just about the Chinese currency.  We also think that the yen, for example, is undervalued, meaning that we think it should be appreciating over the medium term towards a sustainable value.  It's also about other currencies that have drifted away from being what we regard as sustainable or what you might want to call equilibrium values.  So I don't think -- that's what it's about.  It's about allowing exchange rates to adjust, and it's about figuring out how to do that in a context where not all economies are as flexible as that of the United States.

TARULLO:  Simon, there's a slightly different question, though, that arises from the gentleman's inquiry, which is whether the shift of assets from central bank, reserve-type policies to investment policies will itself produce a re-composition of the currency allocation within the fund.  Because, you know, if you're investing globally, you're not going to have 80 percent in dollars, right?  You're going to have as much -- probably, what, closer to 60 percent maybe in dollars?  Has the fund concluded that whatever may happen along those lines is likely to be between trivial and modest when you look at the grand scheme of capital flows, and thus not have having a big impact on exchange rates?

JOHNSON:  I think that this is a very good question.  Let me rephrase it.  It may sound a little technical, but I think it is actually very important, and I'm sorry if I missed it in my initial reply.

So, many of these -- what we're calling sovereign wealth funds are rising out of pools of capital that were initially foreign exchange reserves.  Now, if it's the case that when people were accumulating foreign exchange reserves they were accumulating a lot of dollars -- which may be the case; we don't have full information on that, but that's possible -- and if it's the case that as they shift their portfolios they're moving somewhat out of dollars -- that is not proven and not absolutely clear, but again, it's possible -- what would be the sort of range of the effects on interest rates and on the U.S. dollar?  And I think we will be making public some of our analysis in -- as we go through the year on that.  And there's market analysis out there too, that I think -- much of which I think is quite reasonable.

And the answer -- the bottom-line answer is -- we can argue about exactly how many basis points, but it's not a big or dramatic effect.  And it's certainly, given the flexibility of the U.S. economy -- this is not just U.S. process, right, it's a multilateral process -- I think the U.S. can very easily handle this adjustment.

I would worry, just in terms of capital flows, much more about the ability of some other countries to absorb capital inflows.  So when capital shifts -- if capital shifts for any reason, not just this reason, from the U.S., it's going somewhere.  Where is it going?  Is it going into countries that have a limited ability to absorb those capital inflows?  Are they countries that are going to have appreciation of the exchange rate or some other problems?  That's something that the IMF has to worry about, too.

So on the U.S. side of the process, I think -- we're doing the analysis.  We're going to be showing more of it and debating officially with the private sector on this, but I think the basic message is reassuring.

MURRAY:  Questions?

QUESTIONER:  Herbert Levin.  Putting aside the Asian countries with surpluses for different reasons and discussing only Russia and the petroleum, gas exporting countries -- they have used these exports -- cutting them down or unilaterally raising the prices, cancelling contracts -- when they had political aims against other Europeans, against the Americans, against the Israelis.  Why would one expect them to refrain from using the weapon of their investments, their holdings and sovereign wealth funds, when they have not refrained from using their position as energy exporters in the past?

EIZENSTAT:  Well, I think first of all, Russia is in a very different situation than the Gulf States and the Saudis.  Certainly you can go back to the '67 war, which was a long time ago, and look at the political use of that, but that hasn't happened since.  And it's very unlikely to happen now because they know that if it did, it would cause a massive political reaction.  They would be barred basically from investing in the U.S.  It would be against their own interests.  And as they're trying to integrate into the world economy -- I mean, the Saudis now, you know, are part of the WTO process; they have their own -- they're subject to the WTO rules -- they don't want to be seen, nor do any of the Gulf States, as bad actors.  They are long-term investors. 

I mean, again, one example which caused no political current at all in the United States was just a few months ago.  I mentioned the GE plastics sale -- the plastics division of GE -- to SABIC, which is 70 percent owned by the Saudi government.  Didn't cause a ripple.  It's a commodity.  It has no national security implication.  The Saudis are not going to somehow roll that asset up and take it to Saudi Arabia.  It's going to stay in the United States.  It's an -- it was an undervalued asset for GE.  So I really don't worry about the politicization of the Gulf ones. 

I think Russia's a very different situation.  It's in a position where perhaps Saudi Arabia was in 1967, trying to use its petrodollars to muscle politically in a variety of countries, and there is a legitimate concern.  Even the UK, which is perhaps the single most open market to foreign investment, had concerns when Gazprom was talking about acquiring certain natural gas and pipeline assets in the UK for just that reason. 

But in terms of the Gulf and the Saudis, I really think that that is not a significant concern at all.

MURRAY:  But you raise a kind of an interesting point there, which is that those sovereign wealth funds are well-behaved in part because of pressure and the political pressure they're under from the United States.

EIZENSTAT:  They're all -- it's political pressure here, but it's their own recognition of that political pressure and that if they're perceived as bad actors, if they're not taking the long-term view -- as we've all suggested, most are -- that they -- this would go down to their disadvantage. 

Now, again, you get other sovereign wealth funds -- let's say in the China fund where there is a much more heightened national security concern because what is a private company in China is different than what we might think of as a private company.  The linkages with the Defense Ministry, with the PLA, the potential for leakage of technology and sensitive information is a real concern.

I think it's also important to look back at what Chris Cox said.  I mean, certainly no one would describe Chris as an economic protectionist, but he was talking about the concern -- if there's not transparency -- the concern about potential corruption, market manipulation -- you know, a whole variety of -- I mean, he calls it the sort of ultimate insider trading tool if there's not some greater transparency.

So I think that if the funds recognize it's in not just our interest as host countries, it's in their interest to be more transparent so that you remove a lot of these political concerns -- if they can come to that recognition through the IMF process, we'll all be better off.

Last point: The administration wisely decided not to come up with its own sovereign wealth regulations.  They're doing general regulations for the new bill but not sovereign wealth.  They said, "Let's let the IMF do that.  Let's make it a multilateral issue.  Let's make sure that the Europeans, the Japanese, ourselves -- all the host countries are going to have a general set of guidelines so that we don't shoot ourselves in the foot."  And again, that just recognizes what I think we've all tried to say in different ways, and that is, this is a function of our shifting massive assets of our own abroad, largely to petro countries, largely to countries like China with whom we have a massive current account deficit.  If they don't reinvest those dollars back here, we're the loser.  If Europe sets a set of rules that are less restrictive than we do, then we're taking our dollars, giving it to those countries, and they're going to invest it elsewhere.  That's certainly not to our advantage. 

So having a multilateral set of rules where we're not more restrictive, where we encourage -- yes, with transparency, with due regard to sensitive technologies -- but basically we say, "We want your dollars" -- our dollars -- "We want our dollars reinvested back here," then we're going to just shoot ourselves in the foot.

MURRAY:  Dan, we've had this conversation -- we've been talking for about an hour now on this topic, and we've done it without taking account of the fact that we're in the middle of a pretty hotly contested election campaign here in the United States.  Stuart, although he's a good Democrat, has praised Bob Kimmitt and the Treasury Department and the way they've approached this issue.  Shouldn't we expect the approach to this issue to change if there's a Democratic administration in January?

TARULLO:  Well, I think -- Alan, I don't think we really have an approach yet.  That is, there are some individuals who have had proposals about what they're going to do -- Democrats and Republicans.

When I alluded earlier -- when I used the "groping" metaphor earlier, I actually meant that to convey something good, which is that, you know, a problem comes on the horizon and a couple of things can happen:  One, everybody can kind of get in a lather about it and do something.  And the something -- unless it's been for quite coincidental reasons thought through beforehand, the something usually isn't very good.  And then six months, 12 months, 18 months later you've got to come back around and clean it up.

The second thing that can happen is that people raise a lot of concerns and have a lot of hearings and run panels at the Council on Foreign Relations -- so they get the issue out there.  And people then start to try to navigate through.  And I think where we are right now is people starting to try to navigate through it, which is a good thing, because it allows the manifold character of this phenomenon to be better understood.

MURRAY:  But that supposes that we have kind of a thoughtful navigation through the issue. 

I think both Simon and Mohamed have made reference to the fact that at least some portion of the elevated concern about sovereign wealth funds is probably driven by protectionist sentiment.  And the protectionist sentiment in the Democratic Party right now looks about as strong as it has been in the 25 years that I've been watching Washington.  Is that something to be concerned about?

TARULLO:  Well, I -- look, I mean, you can hear from me, at least, a concern about the medium-term implications of this phenomenon.  But the concern is, itself, multidimensional. 

You know, I think that what Stuart said at the very outset is something that most Democrats, if not all Democrats, would subscribe to, which is that if you're worried about sovereign wealth funds because they've acquired an enormous amount of money because of petroleum, you might want to look at the absence of an energy policy in the United States as a contributing factor.

If you're worried about the fact that sovereign wealth funds have a lot of money because of countries that have been allowed to maintain a currency peg that is kind of inconsistent with good macroeconomic -- good global macroeconomic policy, that's a failure on the part of the current administration as well.  And it's a failure on the part of the country, not just the current administration.

So when we talk -- when Stuart and I talked about the challenges that are presented to the country, it's a challenge of yeah, getting our own policies in order so that we don't make ourselves vulnerable; and second, something Mohamed said at the outset ought to be reinforced as well, which is this is not a one-shot deal in the sense that we're going to have to come to grips with the fact that rising economic powers do have a very different conception of their mode of economic development and the relationship between government and state.

We went through this once before with Japan.  We're talking about political ally where it's essentially a capitalist country and it was a variant on capitalism.  Now we're going to go through it with at least a couple of countries that are not political allies, and I think that entails a set of challenges for whoever is president next year that's quite different from the ones we faced 15 --

MURRAY:  I don't want to turn this into a political debate, but Mohamed, do you worry about the protectionist trends or sentiments that you see in polls and in the political debates?

EL-ERIAN:  Yes, I do worry.  And I worry for the reason that Simon said.

And it's interesting that this question actually came up in the political debate in Las Vegas.  It was posed to Senator Clinton as to where she is.  And she said she was worried. 

The reality, though, I think that as more and more discussion takes place, and as we move from very understandable reactions about nationalism and protectionism to a more fundamental understanding of the underlying flows and the underlying stocks -- I think they're both important -- I think that people will recognize that there is a win-win solution if both parties act.

So in the United States it's a matter of getting the instruments more refined to address national security issues.  And among sovereign wealth funds, it's an issue of understanding that they are not systemically important, which they were not before.  So they are also going through a regime change.  And with power comes obligation, right?  And the obligation is to be more transparent about governance and about process.

MURRAY:  Paul?

QUESTIONER:  I'm Paul Steiger with ProPublica.

As you navigate and grope towards some more refined regime, what sort of sanctions do you envision in the event that whatever best practices or rules -- or whatever designation one wants to give them -- are flagrantly violated?

  TARULLO:  That's me?

I wait with baited breath to see what the fund is going to come up with in terms of its best practices.

My guess -- and I certainly don't want to anticipate what the fund will do -- but my guess is that as a lawyer -- as a law professor, I won't exactly see those as easily -- as standards where you can easily see violations and breaches.  My guess is, in the nature of these sort of fund things, the initial effort at least will be at a fairly high level of generality.

What I -- this is now positive rather than normative.  So I'm sort of predicting what will happen.  And I think what'll probably happen is something like the following:  There'll be an interactive process between what happens at the international level at the fund, unilateral statements by sovereign wealth funds -- what the OAC -- maybe what the OAC does -- on the one hand.  And on the other hand, national regulatory and policy responses, whether in the U.S. or Britain or anywhere else in the world.  And that that's probably a good thing.

That is, if the U.S. response is to say, well, to some degree we can calibrate whether it's a CFIUS assessment or an assessment by the Federal Reserve Board or an assessment by the FCC of a foreign sovereign wealth fund acquisition.  If we can calibrate that in part by seeing whether the investor is signed onto and appears to be actually practicing the principles that have emerged over time, then I think you'd probably get a little calmness in the air.

I can't imagine we're going to have an enforcement system for whatever Simon's group comes up with and I don't think we should.  I think what we should do is to enact laws, regulations and policies to protect our interests, but that we may be assisted in that effort by what the IMF or others try to do in laying out a set of expectations.

You know, there are some who say, this is a law professor?  There are a lot of times where it's better not to try to write everything down in detailed rules and to give yourself a little bit of space to figure things out along the way -- and that's particularly true when information is imperfect.  And as Mohamed says, when everybody is going through an adjustment.

MURRAY:  Stuart, I'm going to get to you in a second, but I just want to ask Simon quickly:  Is it the intention of the IMF to come up with best practices that are at a high level of generality that may get -- (inaudible, laughter)?

JOHNSON:  I think what we're trying to do is bring everyone together.  I think the last count we had 28 sovereign wealth funds who were engaged in talking to us -- some big, some small. 

And I think you -- you know, I'm not going to discuss the details for obvious reasons, but I think it's a very inclusive process.  And I think what people -- it's voluntary best practices.  And I think voluntary best practices can be relatively detailed.  They can be relatively high-level.  It depends on what the participants -- what the participants want.

I think, you know, one lesson -- in thinking about the Harvard management case that Mohamed brought up -- you know, one thing that obviously is very much on people's minds right now, in terms of learning from each other, is how does one -- the issue of insider trading was brought up -- but how does one control one's own traders?  What are the best practices of control mechanisms within these kinds of funds for making sure you -- risk management, for example, is -- well, I don't know if there is one best practice -- I don't know if there are any best practices.

TARULLO:  There is, but we don't have it here.

JOHNSON:  I don't know.  I don't know.

But this are things that are of great interest to the funds themselves.  But I think it's voluntary and it's cooperative.  I hope that it's helpful to them and to all our member governments -- not just the United States.  This is very much a multilateral process.

MURRAY:  Sure.

EIZENSTAT:  I mean, let's not kid ourselves.  The sovereign wealth funds, many of them, are going to resist detailed best practices.  And that's going to force the fund into a very general statement on transparency.  The question then is, if it's very general, what kind of sanction will there be?

First of all, I think there will be very little sanction, because of the investments will be under the radar screen -- will be in assets that don't have any national security implications -- that will avoid the control test.

When, however, you have some that meet that test and that get into the CFIUS process and they remain opaque or simply agreeing to very, very general rules of quote-unquote "transparency", then I think the CFIUS process and the political process will start to have a much harsher spotlight on those individual transactions.

MURRAY:  One last question.  Somewhere --  yes, sir.

QUESTIONER:  Kenneth Bialkin (sp).

This is an illuminating and enlightening discussion.  And it focuses appropriately on the pressures we have today -- namely, financial crisis in our institutions, the need to rescue the economy and the safeguards against abuse.

To what extent, though, should we be thinking now or is there a problem coming down the road by the inclination of corporate management and managers to always want to be on very good terms with their stockholder body?  That is, there isn't a management extant that isn't aware of who owns their stock and of the importance of staying on very good terms with even passive investors, but who have very large voting power should contests for control of companies and issues of management continuity exist. 

And to what extent should we be considering recognizing that any individual sovereign fund won't have more than a small amount of percent.  But collectively speaking, if control of enterprise votes moves to other hands, what is likely to be the impact on management of those relations?  And to what extent will management want to be acting for the purposes of pleasing or accommodating the interests of their individual or largely collective, huge stockholders.

EIZENSTAT:  This is where, Ken, the issue of transparency becomes important, because you want to know if the investor has a commercial, not a political goal.  If he has a commercial goal, then it would be like any other investor, and you don't have to worry about a political payoff.  That's the first thing.

Second, you take a recent investment -- the GIC (sic),  the Chinese-owned entity --

TARULLO:  TS --

EIZENSTAT:  CIG. 

What did they come under criticism for?  It was not because the U.S. was somehow kowtowing to China.  It was in China that they invested in Blackstone and the investment, you know, was worth a third less a couple of months later than when they made it.  So as long as the purpose is commercial, then we're okay.  And that's where the transparency issue and where the IMF guidelines are really important, because it's important that we know that these funds are commercially driven -- like Tomasakin (sp) and others -- and not politically driven.

TARULLO:  But you know, on the transparency issue, I don't know how you're going to assure that, to tell you the truth.  I mean, I just don't -- how do you assure transparency of the sort that here's our investment policy or the strategy and all the rest?  I just don't see how you stop the sort of thing that you were asking about from actually occurring in practice.

You know, I -- I went into one of my corporate law colleague's offices the other day in preparation as I was trying to think through some of these issues.  And I said, so, Bill, if we can't solve the -- if we don't want to put it in CFIUS and, you know, trying to solve in agency-by-agency regulation of an inward investment is unwieldy and dangerous, shouldn't we just say, well, corporate securities loss should assure that the corporation's always acting in the best interest of the shareholders as a group?  And he started laughing. 

So I thought, well, okay, maybe corporate law's not the answer.

MURRAY:  Mohamed, I'm guessing you don't lose a lot of sleep over worrying about corporate managers being too attentive to shareholders?

EL-ERIAN:  I lose sleep so the notion of not losing sleep is something that I look forward to.  (Laughter.)

Ken, your issue of -- the issue of corporate governance, and particularly the balance between ownership and control, is a very complicated one. And it's not just sovereign wealth funds.  What do you do with a hedge fund -- an activist hedge that buys a 3 percent stake and then shorts on the other side using derivative products?  And whose interest is not at all aligned with anybody else, right?  And this is a very, very complex issue that goes well beyond sovereign wealth funds.  It's how we think of a shareholder and how we think about the balance between ownership and control.

Now that I have the mike, just one thing --

MURRAY:  Final word.

EL-ERIAN:  I want to downplay a little bit the expectations coming from the IMF.  I always feel sorry for the IMF, because the minute a really complicated problem comes up, we give it to the IMF and then we expect it to come out with miracles and then it cannot do so on a sustained basis, we then complain, right?  (Laughter.)

This is -- let's also remember that the IMF itself is going through legitimacy questions, right?  And the issues that are in play today, which really are a fact of how quickly the world is changing, is also impacting governance at the IMF, representation at the IMF. 

And I think that to expect a one-round outcome for this is simply unrealistic.  This is a repeated game -- a multi-round game -- where everybody's going to learn, including the IMF.  And I suspect that we'll be talking about this next year and two years and two years.

MURRAY:  Which probably means there will be more sessions at the Council on Foreign Relations on this topic!  (Laughter.)

But thank you all for coming this morning.  Thank you.  (Applause.)

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