Brad Setser

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Cross border flows, with a bit of macroeconomics

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Morgan Stanley/ CIC

by Brad Setser
September 18, 2008

Reuters is reporting that Morgan Stanley has approached the China Investment Corporation (CIC) for additional capital; it isn’t just talking to Wachovia.

It order to get the equity it needs, the CIC’s stake would need to be quite large. Bloomberg reports:

“Morgan Stanley pared its loss on the New York Stock Exchange after the person said China’s state-controlled fund may buy as much as 49 percent of the New York-based investment bank. The person declined to be identified because the talks aren’t public and may end in no agreement.”

This kind of investment (some might say “risky bet”) would have to be approved by China’s State Council. And I would have to say that the CIC has yet to demonstrate a track record of apolitical, transparent management of its external assets — in part because it hasn’t been around for very long and in part because it hasn’t been very transparent.

It also is obviously something that the US regulators would need to approve — and especially in light of the Fed’s recent decision to exempt the CIC from the requirements of the Bank Holding Company act.

UPDATE: The FT’s alphaville has more.

CIC, the Chinese sovereign wealth fund which already owns 9.9 per cent of Morgan Stanley, is definitely talking to the investment bank.

The President of CIC even travelled to the US on Tuesday accompanied by Morgan Stanley’s China CEO.

CIC was previously part of the Bank of America-led consortium that was considering a takeover bid for Lehman Brothers, alongside JC Flowers & Co.

Christopher Flowers manages about $3.2bn of CIC’s money in a fund dedicated to taking stakes in financial institutions.

It is very unlikely CIC would attempt a takeover of Morgan Stanley on its own, and the prospect of the Chinese government effectively owning one of the last two investment banks left on the Street would startle US regulators, to say nothing of the US Congress.

The last line is certainly right — the debate over whether China’s government is a political investor (remember Friday’s news about SAFE’s conditional investment in Costa Rican bonds) — would be turbocharged.

Morgan Stanley is also clearly talking to Wachovia.


  • Posted by fatbrick

    You bet that if CIC invests, it would be political decision. The business risk is just too overwhelming to be compensated. Without the bless of two president candidates, I doubt that the deal would happen.

  • Posted by k

    I’m typing these words as MS stock got massacred on the tape. Unbelievable!

    The deal will happen. We saw the same show this time last week, didn’t we? Now we know the tsunami that released from standing firm against “moral hazard”, we don’t want the world end on next Monday morning (or Sunday night, rather), do we? It has to be done. We’re talking Morgan Stanley here.

    FT reports GAO Xiqing of CIC has been in the US since Tuesday. Surely he didn’t come with an empty suitcase or without State Council blessings.

  • Posted by Twofish

    The world has changed forever…..

    1) The belief that governments should not intervene in the markets and can and should remain completely apolitical and detached is dead.

    2) The belief that the Chinese banks and financial industry are worse run than American ones and that the US should serve as a financial model for the rest of the world is dead.

    3) The belief that concerns about Chinese human rights and the one-party state should cause Western nations to limit the ability of China to play an integral role in the world economy is dead. Now that the world no longer looks to the United States as an economic model, whether the world should look at the United States as a political, social, or legal model is going to be challenged in ways that were impossible last week.

  • Posted by Twofish

    The attractive thing about an investment from CIC is that people thought that they would be getting free money, since the thinking was that US regulators would never, ever, ever allow a PRC firm to control or exert management influence over a US bank. At 10%, you can be a passive investor, but at 49.9%, no way are you going to be passive.

  • Posted by Dave C.

    From Bloomberg, the managers of the China CIC this week already have enough on their plate investing billions of dollars/yuan into state-owned Chinese banking institutions. It is next to impossible that the China CIC will take a majority stake in Morgan Stanley although it is possible that they might bump their current 10% ownership stake by a few percent.

    China Investment Corp., the nation’s $200 billion sovereign wealth fund, will buy stakes in Industrial & Commercial Bank of China Ltd., Bank of China Ltd. and China Construction Bank Corp., the official Xinhua News Agency said in an announcement today.

    CIC’s unit Central Huijin Investment Co. will begin buying shares in the banks in the secondary market immediately, according to the Xinhua announcement. The agency didn’t say how much Central Huijin, which already controls the nation’s largest banks, may invest or give further details.

  • Posted by bsetser

    2fish — the world has changed forever.

    and i agree with the gist of your point 3.

    but there is still something strange to me about the notion that said one-party state would own a major us financial institution with access to us central bank financing when the uS historically has opposed government owned financial institutions (setting freddie and fannie aside) — that is a bit too much change for me. And since i believe that china’s exchange rate policies contributed to a lot of the financial excesses (indirectly but importantly) associated with the housing boom, it also feels a bit strange to turn to China to help recreate a financial system that can avoid these kinds of excesses in the future.

    here tho i would note that the CIC is also in a very difficult position, given that it has taken large losses on its existing 10% stake …

  • Posted by JBW

    Can someone explain what CIC’s exemption from the Bank Holding Company Act means? Does it have added flexibility that, in this case, Wachovia does not?

  • Posted by Dave C.


    I recommend that the China CIC invest/donate a few million dollars to the Council of Foriegn Relations foundation to ensure more objective and favorable coverage of Chinese government policies. Is there a K-Street lobby firm affiliated with Council of Foriegn Relations that the Chinese government can make a political contribution to? How about China PLA state-owned Norinco Corporation or the Great Wall Space Corporation endowing a New York University political science department?

    Very soon, Brad Setser will be singing the praises of Chinese government state ownership as an essential facet of globalization. I am absolutely exaggerating, but it’s an open secret that the Wall Street special interest lobby has captured/hijacked US government financial regulators to the detriment of the greater common society interest.

  • Posted by k

    twofish – The attractive thing about an investment from CIC is that people thought that they would be getting free money…

    I don’t get it. If the deal doesn’t sail through Congress, wouldn’t MS return money back to CIC? Sure, they get several month interest-free loans, but they still won’t get a secured capital source, which I understand is the cause behind the short selling on MS. Where am I wrong here?

  • Posted by charlie

    Let’s see. The US Gov’t takes control of Fannie, Freddie, and AIG, The Chinese gov’t takes control of MS. What’s next? Will the Saudis take control of Citigroup or Wachovia?

  • Posted by bsetser

    JBW —

    I think it works the other way. the CIC already owns several US bank branches in the eyes of the US government, b/c of its stake in BoC, ICBC and CCB. If it took a controlling stake in MS, it would be much harder in my view for it to continue to be exempted from the requirements of a bank holding company. and a bank holding company is unable to own many commercial assets. US law for example doesn’t allow walmart to own a US bank, or a US bank to own walmart.

  • Posted by Cedric Regula

    Mama Mia. MS is gonna buy wachovia and get taken over by the CICs same day??? Wow, who said M&A been slow lately.

    I been think’n about this “debt as weapon” idea some more. I figures maybe we gots the barrel pointed in the wrong direction. How ’bouts we have MS buy WaMu too then, after the CICs buy’em, close the discount window on ’em ’cause they obviously a fureign bank.

    Then the goombah chinese taxpayers can figure out how to keep the finances afloat.

    Wadayaall think of that? Maybe banks start give’n out free toasters again?

  • Posted by TM

    I don’t get it….

    Why would the CIC want to buy MS?

  • Posted by JBW

    Thanks, makes sense. I misunderstood.

  • Posted by gillies

    twofish : the united states would not qualify for entry to the european union on either budgetary or human rights standards. just to put your third worry in perspective.

    and DC : the answer to your repeated remarks about worthless fiat money – it seems that a use may have been found for it : buying up u s investment banks.

  • Posted by Rien Huizer

    That CIC (a corporation owned and directed by the PRC State Council) would aspire to be the controlling owner of something like MS is ludicrous. Unlikely they would want to own something like that and even less likely MS would be able to maintain its many franchises, unless CIC would commit to be a purely passive owner, but one ready to cough up additional capital if and when needed. This apart from the question they would ever get permission to acquire the regulated parts.

    What might be posible is that MS is talking about some king of sleeping partnership if/when MS is acquired by a marginally more robust (and are they in trouble? yes if everyone believes so) financial institution with fewer “international” issues.

    The market idea seems to be that Wachovia (now the only giant-with-an-attitude without an investment banking affiliate of substance) would be MS’ savior. This while Wachovia itself is also the subject of rather malicious rumors.

    Perhaps the US authorities need commercial banking affiliation in order to support an investment bank. This while the only large scale universal banking experiment, Citigroup, does not exactly look like a textbook case of successful corporate strategy, let alone wise capital management.

    Amazing how a problem can degenerate into a solution..

  • Posted by Twofish

    To JBW and bsetser: I think you have misread what the Fed actually did. The Bank Holding Company Act of 1956 basically said that a company can’t own both a bank and a non-bank. For example, you can’t have a company own both a bank and a steel mill, or a bank and an aircraft manufacturing firm. The result of this is to prevent the US from turning into a German style system in which the banks pretty much own everything.

    The issue here is that sense Huijin and CIC own a bank that operates in the United States (namely Bank of China). Without Federal Reserve approval, CIC and Huijin would be classified as bank holding companies and prohibited from owning non-bank companies such as (for example) General Motors or Joe’s House of Pizza.

    The Federal Reserve basically issued a waiver based on the precedent of an Italian bank that said that since CIC are Huijin are government owned that they are exempt from a BHC.

    The waiver does *NOT* give CIC and Huijin permission to accquire a US bank. The letter specifically says that CIC and Huijin may *NOT* operate as financial holding companies (i.e. a company that owns both a bank and an insurance company) without another set of approvals.

    Financial holding companies and bank holding companies are entirely different things. From this letter it looks like that CIC and Huijin were prohibited from investing in *non-bank* US companies before 8/5/2008, and that might explain why its first investments were all financial companies.

  • Posted by Twofish

    bsetser: If it took a controlling stake in MS, it would be much harder in my view for it to continue to be exempted from the requirements of a bank holding company.

    There are two different concepts here:

    bank holding company – a company that owns a bank and a non-financial company

    financial holding company – a company that owns several different types of financial companies

    Not the same thing. CIC and Huijin are allowed to do BHC type things, but not FHC type things.

  • Posted by Jian Feng

    When the head of CIC comes to the US during the tsunami, he is here to get wet, not to go back home with dry and empty hands. Roubini has bluntly demanded the first rule of good manners – do not spit on the plate from which one is given food. The head of MS will make sure that the US government behaves and the US public look the other way.

  • Posted by bsetser

    2fish — i suspect then that a bigger investment in morgan stanley would make the CIC into a financial holding company; i need to reread the letter.

    Rien — smart points; ones I agree with/ wish I had made. If I had to bet, MS is using the CIC to push up Wachovia’s price. But that is a pure guess given the regulatory hurdles to doing a deal, and my guess about the politics of it.

    I also suspect that if the CIC did end up with 49% of Morgan Stanley, the politics of US central bank support for the brokers would get a lot more difficult. I.e. why does China get access to the Fed but not homeowners/ workers?

  • Posted by Matt Dubuque

    Matthew Dubuque

    My best judgment states the following will happen over the weekend:

    1. Morgan Stanley will be “saved” by an injection of funds by the CIC. Brad Setser notes, within a link contained at:

    that early last month, the Federal Reserve gave a special exemption to CIC from the ban on foreign entities owning more than 5% of a bank holding company.

    This was not reported in the financial press, to my knowledge.

    This is ironic because of course it was the Morgan family that repeatedly bailed out the US government prior to creation of the Federal Reserve as a response.

    This bail out of Morgan comes at a heavy price.

    That price is that now China shall assert important controls over US economic and foreign policy in return, similar to IMF austerity regimes.

    This “ringfencing” of toxic waste is the first step.

    Additionally, I believe that President Bush will be forced to agree to be more “cooperative” on the future of Taiwan.

    Just as Argentina and scores of other nations lost control of their destiny at the hands of IMF shock therapy, the US is now held hostage by the self interest of a foreign power.

    The Chinese Communist Party will assist the US in its transition to service of their empire.

    But it will be on their terms.

    Welcome the feudal state!

    This is the end of the American era in world history. The Asian epoch has now begun.

    Please adjust your conduct to these new realities.

    Thank you.

    Matthew Dubuque

  • Posted by Ho Hum

    So, the Chinese move several places up the table in geopolitical terms as they’re the only ones who see strategic advantage in continuing to allow the US to believe in a financial model that everyone else reckons has been blown apart by its excesses.

    Looks like it – if anyone wants confirmation, check out the Japanese suggestion that they could contribute to a global fund to help bail out the US financial system. This fund’s charter reads: “a fund whose investors are those nations who, for reasons of actual historical or anticipated future fear of China, wish to ensure that Chinese influence is diluted sufficiently to stop them (a) exercising regional hegemony in foreign affairs, (b) continuing to manage their own economic affairs in such a way as to export instability to the rest of the world, and (c) the rest of our fears about China…..

    Step forward Japan, the last country to engage in a full scale war with China. All others fall into line behind…