In the wake of the Société Général investment fiasco, rogue trader Jerome Kerviel has been accused of fraudulently siphoning off billions of assets into ill-advised investments. Since the story broke last month nearly every commentator has justifiably called for prosecuting these illicit actions as unequivocal theft.[1]

While its beleaguered stock had lost half its value over the past six months, the financial marketplace reacted swiftly on news of Kerviel's tomfoolery, as the day after trading suspension was lifted on Société Général, its stock dropped 5.5 percent. (It has since had a double-digit rebound on rumors that industry rival BNP is seeking to acquire it.)

Furthermore, management heads rolled as those responsible for "monitoring the operations," the checks and balances, were found liable for their seemingly lackluster oversight.

Rebranding an Old Scheme

While Sovereign Wealth Funds have existed for several decades, it has only been in the last few years that their investment schemes have been investigated and scrutinized. While their portfolios and long-term goals vary, one common trait every state-controlled investment fund shares is that the initial seed money came from the pockets of coerced taxpayers or nationalized resources.[2]

Furthermore, not only are they politically controlled by individuals unduly tempted by outside influence (e.g., bribery), but underneath the euphemism of "investment vehicle" these funds are no different than any other government-managed investment scheme.

The Midas Touch

Armed with billions of dollars in dishonest money, these institutions are lauded as messiahs, brokering 11th-hour bailouts and refinancing troubled megacompanies. According to The Economist, in the past year alone SWFs have "gambled almost $69 billion on recapitalising the rich world's biggest investment banks."

For instance, rash portfolio diversity and misguided investments by some of the largest international banking firms were exposed in the wake of the subprime meltdown and credit crunch. As a result, behemoths such as Citigroup were on the cusp of financial insolvency. However, on January 15th, sovereign wealth funds from Singapore, Kuwait, and South Korea "came to the rescue" and pumped $21 billion into Citigroup and Merrill Lynch.

If one were to believe the uncritical business press headlines and financial sages, these market movers are messianic and their participation is not only highly sought after — and seen as legitimate institutions — but increasingly deified in uncertain times.[3] Their actions become self-fulfilling prophecies because funds and firms they invest in ultimately become safe havens — since SWFs can afford to continually subsidize poorly calculated investments.

Thus, what also goes left unsaid and unquestioned is, who shares the gains or losses?

Shareholder, Stakeholder, or Means to an End?

The government-run Chinese Investment Corporation (CIC) is tasked with managing $200 billion in assets.[4] Last summer it invested $3 billion in one of the worlds largest private equity firms, the Blackstone Group. At the time, it was heralded as a brilliantly executed landmark event. However, within 6 month, the "holdings lost, on paper, about $1 billion, during a time when the composite index of the Shanghai Stock Exchange was soaring."

Who is burdened with the losses? Neither Stephen Schwarzman, CEO of Blackstone, nor Lou Jiwei, chairman of CIC has been fired. In this case, the shareholders have been relegated to an observer status, to the minor leagues, dubiously referred to as "stakeholders." Yet even in this status, no resident of Singapore, Norway, Kazakhstan, or the twenty-odd nations operating SWFs is afforded the same level of power and control that nonprofit donors wield, let alone what normal corporate shareholders have.[5]

As a result, SWFs have not only delayed the necessary house-cleaning mechanism of the markets they rescue, but they increasingly exacerbate the problem by diluting and distorting the marketplace of effective control. And while it is subjective as to what each individual investor should do, the mortgage marketplace was arguably calling for a liquidation of bad business models and entire firms.

The Sword of Damocles

Tasked with conducting meticulous due diligence, even the most seasoned investment manager of a private firm is capable of ill-advised business investments, however they face the ultimate penalty for failure: being canned. Otherwise their firm stands not only to lose clients, but also to face bankruptcy. Thus managers continually live under easily quantifiable, objective, apolitical performance measurements.

$37 $32

In contrast, SWFs, because they are inherently political machinations, need only satisfy political goals in order to stay afloat. As a result, neither profitability nor solvency have to be achieved.[6] Business acumen and entrepreneurial talent are tossed out in favor of those with political capital, clout, and connections.

As a consequence, millions of faceless taxpayers and socialized industries bear the fiduciary responsibility for underwriting all losses. It is an age-old scam, and it is this very fundamental double standard that allows the state to exist and operate in the first place.

This story comes full circle because, while the state continues to rob citizens and petro-markets in the name of taxes, neither government officials nor SWF managers are being indicted for the very same crimes Kerviel is accused of.[7]