Thought experiment

Imagine wealthy Arab investors bailing out Western credit markets.

Actually, you don't have to.  The Financial Times does the heavy lifting in an interesting article-cum-thought experiment.

After all, on one side of the world, an increasingly unpleasant liquidity crunch is taking hold. Just look at the stress emerging in the European covered bond sector and the American money markets – not to mention the continued freeze in the world of asset-backed structured credit.

But on the other side of the globe, liquidity is now so abundant that it seems to be growing on trees. Or, more precisely, gushing out of the ground in the form of $100-a-barrel oil, and abundant gas reserves.

So the question preoccupying some of the brightest minds in modern finance is whether there is any way to turn this contrast into a marriage of convenience? Could the $1,000bn-plus cash now swilling around Gulf Sovereign Wealth Funds, say, ever find its way into the subprime world?

The answer to that question is, probably not.  The article notes three problems with such a scenario:

  1. Gulf investors need assurance that these assets have reached bottom.  That's an iffy proposition, especially with "Level 3" securities whose valuations are based on mathematical constructs instead of supply and demand — the old "marked to model" thing.  Which brings us to…
  2. As the FT notes, "Gulf investors are wary of buying assets that are hard to understand. After all, they have traditionally had a very conservative investment style. And while the new generation of Gulf financiers are becoming more adventurous, change is slow."
  3. Remember the Dubai Ports deal that didn't go through?  U.S. politicians are going to be extremely wary of Arab investors getting a piece of anything American — even worthless CDOs.

That last point is especially important.  As the dollar collapses, sovereign wealth funds will look to recycle their worthless dollars into tangible assets — some of which might well lie within American shores.  But if politicians throw up protectionist walls, it's only going to make a bad situation worse. 

I'm not optimistic on this score.  Younger readers would do well to watch the movie Network.  The 1970s bashing of Arabs buying up U.S. assets will be far worse this time around, with lingering memories of 9/11.