End of Wall Street sovereign therapy?

It appears that the love hate relationship between the western markets and sovereign wealth funds (SWFs) has come full circle within a short span of just 12 months.

Until the subprime crisis erupted in summer last year, the idea of government owned funds from the Middle East and Asia acquiring assets in the US and the Western markets was largely met with animosity and suspicion.

Last October (still very early into the credit crisis), at the IMF and World Bank annual meetings, most US and European policymakers and bureaucrats were anxious to protect their strategic assets from foreign takeovers.

Ahead of the annual meetings, the clamour to restrict the financial clout of the SWFs became so hysterical that IMF economists even thought the world was heading towards capital account protectionism through which countries pick and choose who can invest in what.

Three months later as the subprime related losses metamorphosed into a credit squeeze and solvency crisis, red carpets were rolled out to SWFs that were seen as unwanted foreign raiders a few months earlier.

American politicians and policymakers barely uttered a word as Wall Street giants such as Citi, Merrill Lynch and Morgan Stanley accepted foreign capital.

Just as everyone thought the new found love between the West and the SWFs is blossoming into something long lasting, it appears that cracks are already developing in the relationship.

This time it is SWFs that seem to have developed cold feet. Analysts see the failed attempt by Lehman Brothers to woo Korea Development Bank (KDB) to invest in its shares is clear sign that government backed funds are becoming increasingly disenchanted with Wall Street opportunities.

Lehman's attempt to sell a stake to KDB came to naught as Korean regulators thought the deal was too risky for Korea's banking system while KDB itself was in doubt about the price they wanted to pay.

In the early days of the US financial crisis many SWFs pumped money into some of the troubled Wall Street banks. Year to date SWFs have lost heavily on these investments as shares plunged further.

Rescue mission

Although sovereign funds in the Gulf and Asia were the first to appear on the US financial crisis scene on a rescue mission (largely motivated by the opportunities and cheap valuations), lately many of them have gone into a wait and watch mode due the fear of mounting potential portfolio losses.

Additionally, SWFs from the Gulf are becoming cautious about investing abroad as oil prices have plunged nearly 30 per cent from their mid-July peak.

Although the regional economies are adequately cushioned by the huge surpluses, in the event of a global recession, a further squeeze on credit and lower oil prices, these funds will be forced to dip into their surplus kitty to sustain the huge economic expansion under way.

While the Gulf economies have huge domestic demand for funds to support various mega investment projects, in the recent months local credit markets have been facing acute shortages of funds.

The liquidity fears are reflected in widening credit default spreads. Analysts believe that if the liquidity situation tightens up, SWFs would rather bail out their own domestic institutions.