2007 Witnessed a Revolutionary Change in Global Financial Forces

 

Lyrics

 

Version 1

If buttercups buzz'd after the bee,
If boats were on land, churches on sea,
If ponies rode men and if grass ate the cows,
And cats should be chased into holes by the mouse,
If the mamas sold their babies
To the gypsies for half a crown;
If summer were spring and the other way round,
Then all the world would be upside down.
 

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In 1781, the bedraggled American troops played The World Upside Down as the defeated British troops marched out of Yorktown. Some two hundred twenty-five years later, major financial security firms such as Merrill Lynch, Citicorp, Morgan Stanley, UBS, and Bear Stearns were saved by the financial intervention of Sovereign Funds from countries such as China, Singapore, Abu Dhabi, etc. In essence, Asia came to the rescue of the Western Financial World. This development represents a startling change from the financial world that I entered in 1969 when I started at First Boston. Furthermore, we can expect the trend of foreign ownership to accelerate over the next decade.

 

Big Picture: Could America’s era as the world’s only Super Power be ending?

 

In 1969, the United States was the largest creditor nation in the world, we possessed formidable manufacturing capabilities in almost every industry, and we enjoyed annually huge trade surpluses. In 2008, Toyota will surpass the United States as the world’s largest auto manufacturer. The garment industry has moved offshore primarily to Asia. The primacy of overseas companies in pharmaceuticals, steel, ship building, etc. have brought a global dimension to the world economy. After 2007, the hegemony of U.S. owned financial institutions seems dubious. Moreover, the United States is now the world’s largest debtor nation, owing trillions of dollars to China, Japan, Taiwan, South Korea, etc. For centuries, Great Britain dominated the world economy because of their financial presence, not necessarily their fleet or empire. Thus, Pete Peterson who wrote Running on Empty prophesized a precipitous decline in American influence. Mr. Peterson, the former Chairman of Lehman Brothers and Blackstone, could be the modern day Cassandra. 

 

Sovereign Funds

 

Over the past few years, the enormous dollar holdings accumulated by foreign wealth funds represents a major threat to American ownership of United States corporations and real estate. My definition of a sovereign wealth fund is a fund owned by a foreign country that can purchase stocks, property or bonds of other countries.

 

Sovereign Wealth Funds are already large—worth between $1.5 trillion and $2.5 trillion according to estimates the America’s treasury department.—and will swell larger as governments switch a bigger share of their reserves from low-yielding assets like Treasury bonds to more adventurous investments. Morgan Stanley predicts that by 2015 sovereign-wealth funds could be managing $12 trillion.

 

Were Wall Street Firms Worthless

 

On October 12, 2007, I wrote an essay asking the question whether some Wall Street Firms were worthless. When I wrote this article, I believe that indeed some financial goliaths were at best staggering.

 

In the beginning of my essay, I referred to a Wall Street Journal article that pointed out the impending problem.

 

 “U.S. Investors Face an Age of Murky Pricing.” The authors pointed out explicitly that many securities trade outside of the securities exchanges, and thus lack third party verification. While the authors failed to point out that today municipal bonds, government bonds, and corporate bonds might not trade on exchanges, their prices are tracked pretty accurately. However, trillions of dollars involved in tranches of collateralized mortgage obligations, private equity investments, certain loan commitments, collateralized debt obligations, derivatives, credit swaps, uniquely structured securities, etc. remain in the twilight zone. That is, they are classified as Level 3 securities, and their pricing involves “marking to model.” This pricing is mostly guesswork, and is based upon “management’s best judgment, and “management’s “own assumptions about the methodology that buyers and sellers would use to purchase or sell the security.” In essence, since the dollar value of Level 3 securities held in inventory by such firms as Lehman Brothers, Morgan Stanley, Merrill Lynch, and many hedge funds grossly exceeds their net equity, “The Wall Street Tycoons could be as naked as a jay bird.”

 

What is the likelihood that the Twenty-First Century will witness the resumption of the historical hegemony of Asia? Is it possible that the reign of the West has passed?

 

Since writing this article, Asian Sovereign Funds have poured billions of dollars into leading United States financial institutions so that the later could withstand their huge markdowns primarily attributable to mortgage-backed securities. The financial crisis was exacerbated by the tremendous leverage employed by U.S. financial firms that loaded their balance sheets with junk bond securities on a highly leveraged basis. In order to retain their marketplace credibility, these firms resorted to obtaining cash infusions on onerous terms. For example, Citicorp paid 11% for a convertible preferred security. Morgan Stanley and Merrill Lynch sold equity at a substantial discount from the market.

 

While today, Sovereign funds own a minority stake in U.S. financial firms; their ownership percentage could increase substantially if the U.S. firms have increased markdowns. Moreover, the pressure on Sovereign funds to invest in the United States grows with their prospective war chest rising to twelve trillion dollars by 2015. Before Columbus discovered the New World in 1492, Asia dominated Europe in wealth and culture. 

 

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