Summers Wants IMF to Run $500 Bln Hedge Fund: Andy Mukherjee
March 28 (Bloomberg) -- Larry Summers has a radical idea.
The way I interpret it, the former U.S. treasury secretary and the outgoing president of Harvard University, is suggesting that the International Monetary Fund should stop being just a lender of last resort and become the world's biggest hedge fund administrator.
It's no secret that developing nations -- especially those in Asia -- have foreign-exchange reserves far in excess of what may be required to repay overseas creditors and dispel currency speculation.
What if, as Summers asked in a speech in Mumbai last week, they could turn over a part of this surplus -- he used a figure of $500 billion -- to a ``facility'' managed by the IMF and the World Bank?
With professional managers going to work on this pool of funds, it may be possible to generate at least a 6 percent real return on investment, as opposed to nil now, Summers said.
Most of the profits can be distributed to the investors, with the fund retaining 1 percent of the capital as a management fee -- hedge funds charge their investors between 1 percent and 2 percent. This $5 billion can be ploughed back into the global economy annually as public goods, grants or debt relief.
``Perhaps it is time for the IMF and World Bank to think about how they can contribute to deploying the funds of major emerging markets rather than lending to major emerging markets,'' Summers said.
The significance of Summers's proposal lies in what it can do to alleviate global poverty.
Poor People's Hedge Fund
Unless their governments divert the gains to unproductive state spending, poor people in developing economies will be the ultimate beneficiaries of a pool of assets that is two-thirds bigger than what CITCO Fund Services, the world's biggest hedge- fund administrator, has under its supervision. Can there be a more ambitious plan to make financial markets work for the needy?
There are 1 billion people in developing countries who earn less than $1 a day. Imagine the welfare gain if each of them received a $30 annuity in real, inflation-adjusted terms.
The $500 billion in capital required to produce this return already exists with the developing nations, which hold $1.5 trillion in surplus foreign exchange reserves. All that's needed is someone who has the moral authority to unlock just a third of this treasure chest.
And who else can fill that role if not the IMF?
The case for the IMF's involvement is quite clear-cut.
According to a rule of thumb named after Pablo Guidotti, a former treasury secretary of Argentina, and Alan Greenspan, the recently retired U.S. Federal Reserve chairman, countries should hold reserves equal to foreign liabilities coming due within a year.
Excess Reserves
Between 1990 and 1996, emerging-market economies were following the Guidotti-Greenspan rule quite closely. However, after the Asian financial crisis of 1997-98, they became much more conservative. In the third quarter of 2005, developing countries had foreign exchange reserves that exceeded their short-term overseas borrowings by as much as $1.5 trillion.
This money, as Summers noted, probably is earning a zero real return measured in domestic terms.
``If the wealth tied up in reserves were invested either domestically in infrastructure or in a fully diversified long- term way in global capital markets, 6 percent would not be an ambitious estimate of what could be earned,'' Summers said.
``Indeed the average large higher education U.S. endowment fund has earned a real return approaching 10 percent over the last decade or two,'' Summers elaborated. ``It is natural to ask whether the excess national reserves of emerging markets should not be invested with an aspiration in this direction.''
Singapore, Korea, China
The idea isn't entirely new. Government of Singapore Investment Corp., which has managed the Asian country's reserves for 25 years, has a wide range of assets, including equities, real estate, commodities and private equity.
In July last year, South Korea set up Korea Investment Corp. to manage $20 billion in foreign exchange reserves with a mandate to achieve sustainable returns.
In January, China's State Administration of Foreign Exchange said it wants ``to actively explore ways of investing foreign exchange more efficiently.''
In general, however, when it comes to central banks investing their reserves, liquidity and safety considerations trump returns. Thus they lose money on ``safe and liquid'' investments in U.S. Treasuries, even as private investors make a killing in equities.
To counter their misplaced apprehension of risky assets, so they could earn a better return on reserves, developing nations require ``some form of legitimated international scrutiny and monitoring of central bank reserve investments,'' Summers said.
Rethinking IMF's Role
That opens a whole new opportunity for the IMF and the World Bank. They could create ``an international facility in which countries could invest their excess reserves without taking domestic political responsibility for the process of investment decision and ultimate result,'' Summers said.
It would require enormous resolve on the part of the global financial community to implement a proposal as radical as this.
It is, however, eminently worthy of consideration. Recent research has shown that hedge funds aren't vulnerable to a financial contagion. With sound administration, they could thus become a useful -- and safe -- tool to serve the world's poor.
As Summers put it, ``It is an irony of our times that the majority of the world's poorest people live in countries with vast international financial reserves.''
It's more than an irony. It's a tragedy, and an utterly needless one at that.
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