Puget Sound Business Journal Opinion Piece - Mike Kunath
11/9/2008
Are sovereign investment funds the new economic model?
Premium content from Puget Sound Business Journal by Mike Kunath
Sunday, November 9, 2008
The Western financial system, as we know it, is dead. Not tarnished or cracked. Dead. With its demise go the Anglo laissez-faire financial mechanisms of the Reagan-Thatcher-Kohl era that have held sway for nearly three decades. The American subset, affectionately referred to as “the cowboy experiment,” run by self-centered eccentrics, is at the root of this collapse. After all, New York, not London, had been the creator of new financial products, strategies and entities. We were the innovators. Leverage was the tool. And greed was the measure of success.
It make take years for the damage to be unwound. As world economies deflate with the burst of the credit bubble, nations are ratcheting through a massive deleveraging process, shifting risk from the private to public sector. We must unwind the massive credit bubble created by a system of risk and reward strategies built upon false assumptions, in which the rewards of self-indulgence trampled good judgment. It’s a world economy, and thus a world problem.
In the period of sharp deflation that we are going through, for example, the commodity-dependent emerging economies are only just beginning to feel the consequences. Some will undergo debt defaults, others will endure national bankruptcies. Iceland is a now defunct economy that was run by several extraordinarily leveraged would-be hedge funds disguised as commercial banks. Keep an eye on Turkey, South Africa, many Eastern Bloc countries and Vietnam as you seek emerging market returns.
As the financial ship recovers, the question becomes, what financial system will the world adopt to replace the broken U.S.-centered model? Four similar systems are emerging. Each has at its core a partnership between private (business) and public (state) interests. Two, Russia and China, emphasize the public interest while Brazil and India stress the private. Call it a socialist model, or whatever you want, the West will move in this direction, creating a fifth variation.
The new Western model already is being tweaked by various public partners. In suggesting a public-private partnership, Gordon Brown of the U.K. and Nicolas Sarkozy of France are both ahead of the curve by realizing that debt deflation, which resulted from excessive global liquidity and leverage, must be tackled on a multinational basis, and that giveaway programs are expensive and marginally effective. They understand the urgency, but not yet the new model.
In the U.S., “bailouts” are un-American, but political leaders still cling to them. Neither President Bush nor the presidential candidates understood this. They and Congress pandered to voters with colossal giveaway programs. The tax rebate last spring, the $25 billion loan guarantee to the auto industry and the $700 billion bank bailout — all were pure handouts with no investment return required.
Such giveaways are, or should be, history. Treasury Secretary Henry Paulson is beginning to give shape to the new public-private model. He took $250 billion of that $700 billion and bought equity in major banks with the caveat that the public sector have a share in ownership and insisted upon compensation restrictions on CEOs. In short, he wants a return on his investment. He expects to be proactive, help determine macro strategies, and provide oversight. It’s the beginning of a new model, a model of partnership.
We have an opportunity, possibly a need, to create domestic “sovereign funds,” newly conceived entities that are based upon active management and profit sharing between public and private entities. To date, the sovereign fund concept has been implemented only by foreign governments with excess reserves that are seeking investment returns greater than U.S. Treasury bonds. But just suppose our government changed its habit of “spending money” and began to focus on “investing money.”
Congress might place $50 billion in a new sovereign fund and use it to provide capital to a broad array of participants in the nuclear energy industry, formed as a consortium to build several new facilities. Although the public would provide most of the funding, the deal would require private industry — contractors, design firms and others — to put up funds as well. And the government would expect not only to get its capital back, but to earn a fair return. Sovereign funds could build highways, bridges, fresh-water conservation projects, even sports stadiums.
Sovereign funds could help with another looming problem: the rapidly growing gap between government expenses and falling revenues. The city of Seattle could enter into an agreement with the state of Washington and the federal government to form a sovereign fund with a consortium of businesses to fund a solution to the Alaskan Way Viaduct mess. Local voters would be more likely to approve a one-time tax for investment purposes.
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