Senior Fellow Kevin A. Hassett

Over the years, we have grown accustomed to government bailouts of financial companies. The odd thing about the current credit crunch, however, is that it isn't the U.S. government that is doing the bailing.

Rather, government-owned sovereign wealth funds keep popping up in the news. The flurry of activity has aroused concerns in Washington policy circles, where the hottest question has become: "Are foreign government purchases of U.S. assets a good or a bad thing"?

The answer to that, of course, is unclear, which suggests that congressional meddling is on the way.

Last week's reported $5 billion cash infusion into Merrill Lynch & Co. by Singapore's state-owned Temasek Holdings Pte. may be the latest in a series of high-profile transactions. Last month, the Abu Dhabi Investment Authority bought a $7.5 billion stake in Citigroup Inc., significantly easing liquidity concerns at the bank. China Investment Corp. has since made a $5 billion investment in Morgan Stanley.

Given the breadth of financial stress, it is likely that even more sovereign wealth fund money is going to flow into key U.S. firms in coming months.

The potential cash flow is enormous. Today, the funds manage an estimated $2 trillion to $3 trillion. To offer some perspective, that's significantly more than all the world's hedge funds combined. Some financial analysts estimate that the total quantity of assets managed might grow to $12 trillion during the next eight years.

Breathtaking Scale

It is startling when one pauses and considers the scale of these enterprises. The world's largest sovereign wealth fund is the Abu Dhabi Investment Authority, which manages $625 billion, mostly coming from windfall oil profits in the United Arab Emirates.

The funds in Norway, Singapore, Kuwait and China each manage $200 billion or more. The U.S. even has one, the $40 billion Alaska Permanent Reserve Fund, which has invested the proceeds from mining in the state since 1976.

The world's oldest such fund is the Kuwait Investment Authority, which was founded in 1953 to take advantage of excess oil revenue.

Sovereign wealth funds have long been used to generate an endowment to invest the proceeds from diminishing natural resources, and not just oil.

The Kiribati Revenue Equalization Reserve Fund, established in 1956 to invest the profits from a tax on bird-manure fertilizer exports, manages an investment portfolio that is about nine times the size of the economy of the diminutive Pacific island.

Strategic Goals

Purchases by these funds are different from those by normal shareholders for a simple reason. Governments might not always care about maximizing profit. They have strategic interests as well.

The Chinese might invest in a U.S. semiconductor manufacturer, and then use their influence on the board to reduce activities that compete directly with Chinese producers. Or they might encourage activity that competes with Japanese manufacturers.

Such manipulation isn't unprecedented, although the primary culprits to date have been U.S. state governments. In California, Safeway Inc. found itself fighting against both its own unions and Democrats in the state government when the California Public Employees' Retirement System attempted to influence the election of more union-friendly board members.

Chilling Scenarios

Republican Minnesota Governor Tim Pawlenty attempted to get Pfizer Inc. to moderate increases in prescription-drug prices after investing $463.5 million of the Minnesota State Board of Investment's funds in the New York-based drugmaker's stock.

When foreign governments are involved, the downside scenarios can be chilling. An enemy of the U.S. could, if it had sufficient control of our financial institutions, use that power to gain intelligence about the activities of private American citizens. It might even use its influence to attack the U.S. economy during a time of conflict.

Imagine, to take it to the extreme, that the Chinese bought Citigroup, then shut it down during a conflict with Taiwan if the U.S. tried to interfere.

Fortunately, the activities of foreign governments to date are anything but ominous. Indeed, many analysts liken sovereign wealth funds to the endowment funds held by private U.S. universities. But keeping that image is crucial if the funds are to stay in the game.

Careful, Congress

Accordingly, Congress needs to think more carefully about legislation that can ensure the funds and other government investments are tame.

Fortunately, a simple solution presents itself. If the risk of foreign-government involvement is that the government might pursue a strategy that's not in the interest of profit-maximizing for shareholders, then one need only limit the influence of the government shareholders.

There's an easy way to do that: simply pass a law that prohibits governments from exercising the voting rights of shares they purchase.

Under such a rule, governments would rely faithfully on private shareholders to make the key governance decisions of the assets they own, just as I do when I don't vote the shares that I own through mutual funds.

Since private shareholders care about maximizing the value of their investments, sovereign wealth fund investors would have their interests fully aligned with those of their partners, so long as those interests are solely focused on long-run returns.

Given that government meddling could be pernicious, and already has occurred at the state level, it seems essential that such legislation be on the agenda in 2008.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.