Wachovia/ Morgan Stanley/ CIC?
The reporting from Asia on Friday suggested limits to the CIC’s interest in Morgan Stanley. Restrictions on the ability of foreign banks to participate in the “TARP” (the current acronym for the bailout) might be another.
But the Wall Street Journal’s reporting (see Lucchetti, Enrich and Sidel) suggests that discussions are ongoing:
“Wall Street firm Morgan Stanley and Wachovia Corp. plowed ahead with merger talks Friday, even though announcement of the U.S. government’s crisis-fighting plan eased the pressure to race into a deal, people familiar with the matter said. Morgan Stanley’s board was expected over the weekend to discuss a deal, which may take an interesting twist. In one scenario being contemplated in New York, China Investment Corp. would take a significant stake in the combined company.In one scenario being contemplated in New York, China investment corp would take a significant stake in the combined company. … CIC’s interest might be contingent on Wachovia being able to offload some of its mortgage assets. So far, the CIC discussions has been preliminary and hasn’t been broached with Wachovia’s board.”
This sounds like a scenario that would need to be contemplated in Washington and Beijing as well as New York. Moving risky assets over to the books of the US taxpayer to create a “good bank” that appeals to the investment arm of China’s state council (an accurate, if undiplomatic, description of the CIC) would be a significant move – even in a week marked by a host of significant moves. The US government would effectively be a party in the deal.
I can see how say a voter in Ohio that – correctly – believes that China’s neo-mercantilist policy of accumulating foreign assets to hold its exchange rate down and support China’s export sector has contributed to the difficulties segments of US manufacturing have faced over the past few years might not look favorably on a deal that requires the taxpayer to assume downside risk and gives China’s government the upside. The US Congress has bulked at increasing China’s IMF quota because they haven’t wanted to reward China for intervening in the currency markets. The ideas that Morgan Stanley seems to be considering would seemingly require rather direct bit of US government assistance for a agency that helps to manage foreign assets that the US government doesn’t think China should be accumulating in the first place.
Yes, a CIC investment could help the banks raise needed equity capital and thus offers a potential alternative to an even bigger investment by US taxpayers. But a large CIC stake would also start to raise issues about who should provide the government backstop for the combined institution: China or the US? Bailing out US banks is one thing. Bailout out a Chinese-government-owned US bank is another.
That question hasn’t come up in the past because governments generally haven’t owned financial institutions with large operations outside their home markets. Singapore I guess is a partial exception; Temasek has large stakes in a lot of financial institutions. But it is at least worth starting to consider who has responsibility for such an institution in the new world of state capitalism.
Finally, it is a little puzzling how China’s government could find Agencies too risky without a US Treasury guarantee (Chinese representatives apparently told the US that they expected the US to “do whatever is necessary” to protect the Agencies) and simultaneously find Wachovia/Morgan Stanley’s book attractive. It presumably has rather more risk than most Agency bonds. On the other hand, it probably is a stretch to assume that China has a coordinated external investment policy now that management of its reserves has effectively been split between two (or more) rival institutions …
appreciate the sarcasm in the last paragraph, but there’s no need to be coy. the chinese are more blunt about it. read the coverage in wapo
do you have a link?
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/19/AR2008091902012_2.html?hpid=topnews&sid=ST2008092001054&s_pos=
I really like your post but try not to be over-patriotic. China has been wanting to divert away from Treasuries to risker investments for a while now. Remember the Blackstone investment? Naturally they’d want to get the best deal possible if buying stakes in MS so as not to lose a bunch of money this time.
Chinese are trying to avoid a depression, and they’re now forced to pony-up for ABS’ to keep the game going.
Tough luck.
Christian
I am not sure China has been wanting to diversify away from treasuries. rhetorically, yes — but my take on the FRBNY and Tic data is that it shows an increase in Chinese demand for treasuries. certainly v agencies. but presumably v all risk assets.
The problem I have with a structure that allows the CIC to put money into wachovia and MS while limiting the CIC’s risk of a second blackstone or morgan stanley is that the risk that the CIC doesn’t want would effectively be assumed by us taxpayers. And if that is the case, why shouldn’t us taxpayers rather than the Chinese taxpayers get the upside?
I understand China’s desire for equity exposure. Call me old fashioned but I think that desire should be met with a lot index funds, transparently disclosed — not be taking a potentially controlling stake in an institution with an enormous leveraged portfolio of us assets. China, remember, already holds about $1.4 trillion of us assets (my estimate). And in the long-run, i would like to see a reduction in Chinese (state) demand for US assets, not ever rising purchases …
Moldbug’s one-sentence recovery plan: issue new USG liabilities in exchange for all outstanding shares of all 799 no-short companies at Friday’s price, bringing them all onto USG’s balance sheet, converting all their obligations to USG notes of equivalent maturity, closing out all derivatives and other funky instruments at the present market price.
Ie: nationalize. Grasp the nettle. Lending to is not nationalizing. Buying mortgages is not nationalizing. Dear Hank: embrace your inner Bolshevik! Don’t let those nasty economic royalists bother you. We’re going there one way or another, so why not do it in one step?
Nationalizing the financial industry – a step that other OECD countries would probably have to follow – may not be the only way to allow the free market to work out the correct price of MBS. But it is the only way I can think of.
(In particular, a reverse auction as proposed at present seems unlikely to succeed – it will have the same problem as the MLEC, a paucity of willing sellers. The markets for MBS are frozen for a reason: the holders of these goods would be insolvent if they accepted the present market price. But a reverse auction is a way to generate very low prices for these goods. It creates the incentive for banks which hold the toxic sludge to insist that the particular barrels of sludge they hold are “good sludge,” not “bad sludge.” They can sustain this insistence only by declining to sell their sludge on the bad-sludge market – which is exactly what the TARP will become, I fear.)
I have not done the math, but I am pretty sure a full nationalization of the financial would “cost” – ie, require the issuance of – a lot more than 700 billion dollars. But these dollars already existed, albeit in the form of informal contingency options. USG needs to find all these shadow dollars and swap them for actual securities.
I also wish people would stop talking about the “cost” to the “taxpayer.” If Paulson issues 700 billion dollars to buy mortgages, the IRS will not compensate by increasing its collections correspondingly. While diluting the dollar is always a zero-sum game, nationalizing the financial system is better seen as a way to avoid antidilution – ie, deflation.
Exchanging genuine dead presidents for unstable, informal and contingent promises of dollars is, if implemented properly, (a) dilution-neutral, (b) portfolio-neutral, and most importantly (c) fair to everyone. It is also very unlikely to happen, but c’est la guerre.
moldbug:
we have deficits: how the hell can we pay 700b? answer: they will, they being swf’s that intended to buy intel and boeing and long beach, will now get toxic cmbs and mbs because they are dictatorial paper-tigers and can’t ride out a real depression like the US can.
Yous folks worry ’bout the CICs too much, I tinks.
Been talking to Uncle Alfredo..he owns a grocery store..about CDOs, C3POs and all dat mortgage paper dat got packaged every witch way.
He sez nut’ing really wrong wid doing dat and he do it all de time in de grocery biz.
Reason being is da “price point” is very important in de grocery biz ’cause dat whad de customer sees look’en at all dem sales and coupons.
So’s like wid eggs what Uncle Alfredo does is he puts 3 eggs from da medium size carton inta de extra large carton, ana gets more extra large cartons for de same price point.
Capice?
He sez Wall Streets been do’en de same ting, and de CICS got nut’ing to worry about. It ain’t toxic at all!
So’s all we needs to do is give da CICS all 799 finincial service companies, rename da company Bank of CICS, den close de Fed so’s dey can’t get no more of our tax money.
Den we go back to doing what we was doing, instead of worry’en about dumb stuff like if’n yous can loose yous whole roll in a money market account.
The Washington Post article is very interesting. Now that Comrade Wang is meeting Comrade Paulson, the engagement of China in Uncle Sam’s failed businesses has gone up a notch significantly. CIC is just a little pawn in the entire scheme. The Chinese Communist Party’s motto has always been “The Party directs the guns”. Since China secured peace with the United States, the CCP has increasingly found that the US fiat is a much more effective weapon and thus needs to be under the Party’s control. Some in the US have asked China to be a responsible wingman to run the world together. While China has no intention to be #2, it does want to see whether #1’s proposal is for real. A 49% stake in MS/Wachovia from CIC would be a perfect litmus test. China is modest enough to only ask for 49%, not 51%. The United States should be mature enough to let the deal go through and set a good example for the happy marriages ever after. The bickering era of the sino-US relationship has gone with the total failure of #1’s propaganda on free market and democracy. When the senators dare not tell the public Comrades Paulson and Bernanke’s verdict on the state of the economy and very possibly the future of the Union, the Congress should stop acting like a two year old and behave accordingly in the international system that US has set up. A rich kid with no spine will sooner or later recognize after bankruptcy that living on other peole’s charity is the least painful way to survive. The alternative solutions require too much saving, disciplines and sacrifice that only his great grand father could tolerate. And don’t worry about CCP’s risk tolerance. The combat-harden rulers of China had nothing mere 20 years ago. It is not terribly a big deal to lose a couple of hundred billions dollars. The value of MS is its comrades, who will help China to better understand Uncle Sam’s most critical operating system.