The end of liberalization

“I don’t think there was any banker in that room who was going to look us in the eye and say they had too much capital. In a relatively short period of time, people came on board.”
—Henry Paulson, US Treasury Secretary, reported in The New York Times

Here’s a multiple-choice question that would have been hard to contemplate at this time last year:

In order to thaw the frozen credit markets and safeguard American banks against collapse, the US government plans to:

A. Buy preferred shares, worth $250 billion, in large US banks.
B. Purchase up to $700 billion of illiquid asset-backed securities from banks and other financial institutions.
C. Purchase or compel sale of the rotting real estate assets in order to facilitate their rehabilitation.
D. Help defaulting homeowners remain in the their homes by forcing lenders to refinance the terms of their loans, or just outright buying them and refinancing the loans itself.
E. All of the above.

The answer is E. That’s right, there’s no need for anyone to walk away with a consolation prize, except of course, the taxpayer, who gets stuck with a bill totaling over $2 trillion.

Now, bear in mind, that $2 trillion is neither spent nor ‘lost’ at this point. In fact, the government could actually make money on the deal, but I wouldn’t hold my breath on that score.

It seems pointless here to voice objections to these maneuvers. It’s a fait accompli. But by turning the government into a massive sovereign wealth fund (SWF), we are driving the final nail into the coffin of economic liberalization, a concept that has been on life support for at least three years now.


The separation of capital and state

One could see the beginning of the end in Europe in 2006. Since the 1990s, European governments had agreed in principle, if less than earnestly, to follow a course of liberalization, whereby government stakes in various industrial concerns over time would be reduced to levels deemed acceptable by economic liberals (bear in mind that ‘liberal’ in this context roughly equals what is considered ‘conservative’ economics in the US, hence the term liberalization). The thinking predominant at the time was that Europe’s economies would slowly transform themselves into something closer to the so-called Anglo-Saxon model, in which proper walls would be erected between government and business and greater economic competition would ensue.

But something happened on the way to free-market paradise.

Many political actors in Europe never really did put away their old notions of “national champions,” that is, dominant, state-owned companies, and they needed only an excuse to thwart the movement toward greater liberalization. One of the first signs of this recalcitrance was visible in early 2006, when Gaz de France, a state-owned gas giant, bid $46 billion for French water utility Suez. This was done at the behest of the French government for the sole purpose of blocking a rival bid from Italy’s Enel, which is itself a state-owned utility.

This battle of state-owned utilities prefaced a period of stagnation in the movement toward greater liberalization and conveniently highlights the key reasons for liberalization’s demise: (a) energy insecurity and (b) the use of energy receipts by state-owned firms to take over competing foreign concerns.

In its early stages, the resurgence of state-owned firms occurred despite howls of protests from liberalizers, and I myself was greatly perturbed by their behavior, but in retrospect, their actions betray a certain realism about the future that bright-eyed economic liberals like myself lacked at the time. That realism was grounded in geopolitics and energy. In effect, there was a race going on between liberalization and sovereign wealth. Liberalization lost.


The role of energy

A few years ago, as energy prices began their run-up, the rich world started forking over a mountain of cash to international energy concerns, most of them mere arms of foreign governments, among them Russia, Saudi Arabia, and Venezuela. To their credit, the European plutocrats saw – or were willing to see – that this great shift in global wealth signaled the emergence of a fundamentally different paradigm, a paradigm in which the concerns of economic liberals would count for very little. They could see that those energy receipts would become financial weapons that would allow foreign states to game the liberal economic system. Private capital simply can’t compete with such massive financial resources.

In the summer of 2005, that lesson began to hit home in the United States when China National Offshore Oil Corporation (CNOOC) bid $18.5 billion for Unocal, a large US oil company. This bid created a firestorm on Capitol Hill, as nationalist politicians railed against the purchase of a US company by the Chinese, and the political rhetoric – being not much different in tenor than that of European economic nationalists – put economic liberals in a tough position.

Up until 2005, economic liberals held the heights in the ongoing conversation about how to structure the global economy. Globalization was their baby – it was their theories that powered globalization; it was through their participation that the global economic infrastructure was expanded and given a role. The US and UK (hence the ugly pejorative ‘Anglo-Saxon’ economics) were usually in the vanguard of this movement, and that’s why the Unocal transaction posed such a problem for liberals. After so much vituperation concerning the dangers of economic nationalism – especially that directed at Europe – how could liberals fail to support CNOOC’s bid?

Actually, there were very solid reasons for killing the Unocal bid, but liberals did a poor job of articulating them. The Chinese government owned 70% of CNOOC; Unocal was a private American company. What on earth is ‘liberal’ about signing over a major oil company to the control of a foreign government? But this is not how the rejected bid was framed in the global conversation. Instead, it became an instance (allegedly all-too-typical) of American perfidy, of Americans talking the talk but not walking the walk. This is sheer nonsense, but it did not help economic liberals that private American companies had in the past been sold to firms owned by foreign governments. In any event, it put liberals on the defensive, and they have been there ever since.

The major differentiating factor in the CNOOC/Unocal case was energy. After all, it’s not like the US had a closed-door policy to Chinese companies. In 2004, Lenovo bought IBM’s global personal computer business for $1.75 billion, and just prior to CNOOC’s ill-fated bid, Haier had teamed up with American private equity firms to bid $1.3 billion for Maytag Corp. (Maytag was ultimately purchased by Whirlpool Corp.). But computers and white goods aren’t oil and gas, and despite reports detailing a lack of Chinese deal savvy, more likely, the Unocal bid was dead on arrival.


From there to here

Things only got worse for economic liberals during 2006 and into 2007. First came the Great Ports Squabble, in which Dubai Ports World, a government-owned entity based in the Middle East, purchased the UK’s Peninsular and Oriental Steam Navigation Company (P&O). P&O held operating leases on several American ports. The thought that such operations would be handled by an Arab government sent politicians through the roof (never mind that Dubai is a solid American ally), and the politicians ultimately forced DP World to divest P&O’s American ports business, again, over howls of protest from economic liberals. Of course, energy again was key, as the ruling Al-Maktoum clan had leveraged the emirate’s once-plentiful oil and gas resources into a diversified economic engine, but just as important, Americans were getting a very tangible lesson in what I touched on earlier: how petrodollars can be used as financial weapons. Even though oil and gas currently account for very little of Dubai’s wealth, the impression this transaction made on the average American was unmistakable.

This impression was only heightened over the course of the next twelve months as a new term made its way into the average American’s lexicon: sovereign wealth fund. SWFs have been around for a long time (the Kuwait Investment Authority was formed in 1953; see chart to right), but it was only when the flood of oil revenues came in the 21st century that the SWFs needed new strategies to invest all that excess liquidity, which began finding its way into the M&A arena. It is at that point that economic liberals began to take notice.


SWFs really exploded on the scene during the current financial crisis, as several funds made key investments in Western financial institutions, notably Citigroup and UBS (see chart, right). It is amazing to me the speed with which the liberal consensus evaporated during the financial crisis. As Western banks desperately sought out new capital to shore up their weak balance sheets in the face of the subprime crisis, few folks condemned the SWF investments. After all, beggars can’t be choosers. At the turn of the century, it was unimaginable that large chunks of Western banks would end up in the investment portfolios of Arab and Asian governments by the end of the decade. When the deed was done, the relative ho-hum reaction spoke volumes, and it was then that I knew that economic liberalism was spent as a global force of economic transformation.


Uncle Sam: SWF

Accepting money from foreign SWFs is one thing; turning the US government into a giant SWF is something else altogether, but that’s where we are. Some of the proposed bailout actions are not unprecedented. After all, during the Great Depression, the government intervened heavily in the credit markets. By itself, the Home Owners’ Loan Corporation acquired and refinanced over one million delinquent mortgages between 1933 and 1936. What is unprecedented is the variety and depth of the current set of interventions. I’m being a little flip, here, naturally. There are plenty of substantive reasons why calling Uncle Sam a SWF is misleading or plain wrong, but from the perspective of a bruised and beaten economic liberal, the differences are meager and cold comfort.

I am not here in a position to say whether I agree with the specifics of each and every intervention. Broadly, however, my thinking has evolved to the point where I can say, like Henry Paulson, that the intervention is “objectionable,” but necessary. I still have heavy concerns about how the bailout might compromise the Fed’s ability to combat inflation. I still have concerns regarding the government’s ability and competence in arranging the scores of workouts needed. I still have concerns that the current plans on the table leave too much unproductive rot in the system. I still have concerns that the plans short-circuit our necessary sense of moral hazard. But, all of that notwithstanding, the move to free up credit is absolutely necessary if we are serious about saving otherwise healthy businesses from decay. This is a case where, for the time being, we will have to keep the baby and the bathwater. Still, at some point, the bathwater will need to go if anyone wants to use the tub in the future.