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COMMENTARY

DOW JONES REPRINTS This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit: www.djreprints.com. • See a sample reprint in PDF format. • Order a reprint of this article now. The Secrets of Intangible Wealth By RONALD BAILEY September 29, 2007; Page A9 A Mexican migrant to the U.S. is five times more productive than one who stays home. Why is that? The answer is not the obvious one: This country has more machinery or tools or natural resources. Instead, according to some remarkable but largely ignored research — by the World Bank, of all places — it is because the average American has access to over $418,000 in intangible wealth, while the stay-at-home Mexican’s intangible wealth is just $34,000. But what is intangible wealth, and how on earth is it measured? And what does it mean for the world’s people — poor and rich? That’s where the story gets even more interesting. Two years ago the World Bank’s environmental economics department set out to assess the relative contributions of various kinds of capital to economic development. Its study, “Where is the Wealth of Nations?: Measuring Capital for the 21st Century,” began by defining natural capital as the sum of nonrenewable resources (including oil, natural gas, coal and mineral resources), cropland, pasture land, forested areas and protected areas. Produced, or built, capital is what many of us think of when we think of capital: the sum of machinery, equipment, and structures (including infrastructure) and urban land. But once the value of all these are added up, the economists found something big was still missing: the vast majority of world’s wealth! If one simply adds up the current value of a country’s natural resources and produced, or built, capital, there’s no way that can account for that country’s level of income. The rest is the result of “intangible” factors — such as the trust among people in a society, an efficient judicial system, clear property rights and effective government. All this intangible capital also boosts the productivity of labor and results in higher total wealth. In fact, the World Bank finds, “Human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries.” Once one takes into account all of the world’s natural resources and produced capital, 80% of the wealth of rich countries and 60% of the wealth of poor countries is of this intangible type. The bottom line: “Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity.” What the World Bank economists have brilliantly done is quantify the intangible value of education and social institutions. According to their regression analyses, for example, the rule of law explains 57% of countries’ intangible capital. Education accounts for 36%. The rule-of-law index was devised using several hundred individual variables measuring perceptions of governance, drawn from 25 separate data sources constructed by 18 different organizations. The latter include civil society groups (Freedom House), political and business risk-rating agencies (Economist Intelligence Unit) and think tanks (International Budget Project Open Budget Index). Switzerland scores 99.5 out of 100 on the rule-of-law index and the U.S. hits 91.8. By contrast, Nigeria’s score is a pitiful 5.8; Burundi’s 4.3; and Ethiopia’s 16.4. The members of the Organization for Economic Cooperation and Development — 30 wealthy developed countries — have an average score of 90, while sub-Saharan Africa’s is a dismal 28. The natural wealth in rich countries like the U.S. is a tiny proportion of their overall wealth — typically 1% to 3% — yet they derive more value from what they have. Cropland, pastures and forests are more valuable in rich countries because they can be combined with other capital like machinery and strong property rights to produce more value. Machinery, buildings, roads and so forth account for 17% of the rich countries’ total wealth. Overall, the average per capita wealth in the rich Organization for Economic Cooperation Development (OECD) countries is $440,000, consisting of $10,000 in natural capital, $76,000 in produced capital, and a whopping $354,000 in intangible capital. (Switzerland has the highest per capita wealth, at $648,000. The U.S. is fourth at $513,000.) By comparison, the World Bank study finds that total wealth for the low income countries averages $7,216 per person. That consists of $2,075 in natural capital, $1,150 in produced capital and $3,991 in intangible capital. The countries with the lowest per capita wealth are Ethiopia ($1,965), Nigeria ($2,748), and Burundi ($2,859). In fact, some countries are so badly run, that they actually have negative intangible capital. Through rampant corruption and failing school systems, Nigeria and the Democratic Republic of the Congo are destroying their intangible capital and ensuring that their people will be poorer in the future. In the U.S., according to the World Bank study, natural capital is $15,000 per person, produced capital is $80,000 and intangible capital is $418,000. And thus, considering common measure used to compare countries, its annual purchasing power parity GDP per capita is $43,800. By contrast, oil-rich Mexico’s total natural capital per person is $8,500 ($6,000 due to oil), produced capital is $19,000 and intangible capita is $34,500 — a total of $62,000 per person. Yet its GDP per capita is $10,700. When a Mexican, or for that matter, a South Asian or African, walks across our border, they gain immediate access to intangible capital worth $418,000 per person. Who wouldn’t walk across the border in such circumstances? The World Bank study bolsters the deep insights of the late development economist Peter Bauer. In his brilliant 1972 book “Dissent on Development,” Bauer wrote: “If all conditions for development other than capital are present, capital will soon be generated locally or will be available . . . from abroad. . . . If, however, the conditions for development are not present, then aid . . . will be necessarily unproductive and therefore ineffective. Thus, if the mainsprings of development are present, material progress will occur even without foreign aid. If they are absent, it will not occur even with aid.” The World Bank’s pathbreaking “Where is the Wealth of Nations?” convincingly demonstrates that the “mainsprings of development” are the rule of law and a good school system. The big question that its researchers don’t answer is: How can the people of the developing world rid themselves of the kleptocrats who loot their countries and keep them poor? Mr. Bailey is Reason magazine’s science correspondent. URL for this article: http://online.wsj.com/article/SB119103046614343129.html

How Economy
Could Survive Oil
At $100 a Barrel

Compared to 1980, U.S.
Is More Able to Handle
Once-Unthinkable Rise

By PETER FRITSCH and KELLY EVANS
September 29, 2007

The world economy has managed, with some indigestion, to swallow the rise of oil prices past $80 a barrel. How well could it survive $100 a barrel?

The answer is quite well — so long as several conditions still hold true. The price rise would probably have to be gradual. Inflation couldn’t get so bad as to force big interest-rate hikes. Oil-rich nations would need to pump their profits back into U.S. and European economies.

All of this has happened so far. The happy confluence may continue, though fears remain strong that high energy prices will tip the U.S. into recession.

A host of factors, including tight oil supplies and a weak U.S. dollar, suggest that oil prices have further to rise. Some analysts continue to believe that oil is destined to reach an all-time high, as measured in today’s dollars, of more than $101 a barrel. The record was set in 1980. On Friday in New York, the benchmark crude-oil futures price closed down $1.22, or 1.5%, to finish at $81.66, a little more than $2 off the all-time high, not adjusting for inflation.

High oil prices could lead to ugly consequences if they hit consumers’ pocketbooks — especially in the U.S., where the housing slump is already hurting the economy. Consumer spending has been the primary engine of growth in the U.S. in recent years.

Target Corp. was among the major retailers in the last week cutting sales forecasts. Target expects September sales at stores open at least a year to rise just 1.5% to 2.5%, down from an earlier expectation of 4% to 6% growth.

For all the concern, the world today is better equipped to swallow expensive oil than it was when Jimmy Carter was installing solar panels and a wood-burning stove in the White House.

The main reason has to do with what some call the Wal-Mart effect. For every extra dollar taken from drivers’ pockets at the pump in the form of higher prices in recent years, low-cost exporters from China and elsewhere have put roughly $1.50 back in the form of cheaper retail goods. Even at today’s near-record prices, U.S. households today spend less than 4% of their disposable income at the pump, vs. over 6% in 1980.

Current prices are also a reflection of a strong economy, not an oil embargo or war in the Middle East. Since a market-share war between Saudi Arabia and Venezuela flooded the market with oil and drove prices to below $11 a barrel in 1998, oil prices have risen nearly eight-fold. During that run, the global economy grew roughly 5% each year.

Strong growth in places like China helps take some of the edge off the oil-price blow for U.S. and European companies such as Detroit’s Big Three auto makers. Many emerging markets are hitting a “takeoff” stage, where per-capita income reaches a level that sparks serious auto demand, says Ellen Hughes-Cromwick, Ford Motor Co.’s chief economist. Growth in emerging markets is a “structural development” that is “less sensitive to oil-price changes,” she says.

“There’s a more relaxed attitude now,” said Daniel Yergin, a noted oil historian and chairman of Cambridge Energy Research Associates. At a recent event promoting Alan Greenspan’s new memoir, Mr. Yergin asked the former Fed chief on stage if $80 oil was a concern. “He basically shrugged and said, ‘Not so far,’” Mr. Yergin recalls.

Economists see global growth slowing but still chugging along at a relatively healthy 3% this year and next. High oil prices also mean more money for oil-producing nations such as Russia and Saudi Arabia to invest globally. “If resource owners are now getting a bigger piece of the pie to spend and invest, then $100 oil shouldn’t be a problem” in the absence of a U.S. recession, says independent energy economist Philip Verleger Jr. “And that investment is happening.”

Fundamental Shift

Such sanguine views, while they are far from universal, reflect a fundamental shift in economists’ understanding of how energy prices affect the economy.

Historically, oil prices have doubled or trebled in a matter of weeks because of sudden and sharp supply disruptions, such as those in 1980 following the Iranian revolution and the outbreak of the Iran-Iraq war. That prompted the Fed to raise interest rates sharply in an effort to head off a spiral of inflation.

Current Fed chairman Ben Bernanke has spent a lot of time trying to understand such shocks. In 1997, he analyzed the effects of sharp rise in prices during the oil shocks of 1973-75, 1980-1982 and 1990-91 in the Brookings Papers on Economic Activity. His surprising conclusion: The Fed’s cure for high oil prices was worse than the disease.

“The majority of the impact of an oil price shock on the real economy is attributable to the central bank’s response to the inflationary pressures engendered by the shock,” he wrote. Today, that view is fairly mainstream among central bankers.

Mr. Bernanke’s Fed recently responded to the subprime mortgage crisis by cutting benchmark interest rates for the first time in four years. By implication, the Fed was saying it was more worried about the fallout from credit-market gloom than about the risk of inflation. At a time of record energy prices, that’s a risky but educated bet.

Growing fuel efficiency could also blunt the blow of higher prices. James Barnes, a Union Pacific Corp. spokesman, says the railroad has bought more fuel-efficient locomotives and trained engineers to operate trains in ways that conserve fuel. “From a macro level, we would anticipate that rising oil costs will make us more competitive [with trucks] and potentially drive more business our way,” Mr. Barnes says.

Engine of Growth

In China, the engine of growth on which many are counting, other energy sources can make up for oil. China uses oil for only 21% of its energy needs, with most of the rest coming from coal. Unlike in the U.S., where imported oil goes to fill people’s gasoline tanks, China mainly uses oil in industrial settings, where coal may be an alternative. Greater coal use, however, would also exacerbate China’s already serious pollution problem and speed up emissions of gases that contribute to global warming.

Still, some fear the impact of $100-a-barrel oil would be too powerful for the U.S. to overcome. “If we aren’t already headed for a recession, it could push us in that direction,” says Bill Zollars, chairman and chief executive officer of YRC Worldwide Inc., a large trucking company based in Overland Park, Kan. “With a very fragile economy like we have now, this could be another burden for the consumer and the business community.”

Mr. Zollars says shipment volumes at YRC, which serves many retailers and manufacturers, have dropped to 2003 levels. “We are not seeing the kind of volume we would normally expect” ahead of the Christmas retail season, he adds.

Fall in Demand

Higher oil prices could hit the beleaguered auto and airline industries. Detroit is still digging out from the fall in demand for sport-utility vehicles caused by the climb in gasoline prices. Paul Ballew, General Motors Corp.’s top sales analyst, explained sluggish industry sales earlier this month by citing in part high fuel prices, which he called “effectively a tax on U.S. households.”

For now, most economists expect oil prices will stay high through next year. An unexpected hurricane in the Gulf or a sudden disruption to oil flows from a big producer like Iran or Mexico could push oil to $100, they say.

Demand is chugging along. The Paris-based International Energy Agency sees world oil demand in the fourth quarter rising by 2.8%, or 2.3 million barrels a day from a year ago, to nearly 88 million barrels a day.

Of course, those forecasts could go awry if the U.S. economy tanks and brings Europe and Japan along with it. Then demand would likely ease, and oil prices could fall, perhaps significantly. And then, the world would have something else to worry about.

–Daniel Machalaba, Shai Oster, Susan Carey and Mike Spector contributed to this article.

Write to Peter Fritsch at peter.fritsch@wsj.com and Kelly Evans at kelly.evans@wsj.com

http://online.wsj.com/article/SB119102487310743331.html?mod=rss_whats_news_us

Jim Rogers Sees `Skyrocketing’ Prices for Commodities (Update3)
By Betty Liu and Eric Martin

Sept. 24 (Bloomberg) — The Federal Reserve’s interest rate cut was a mistake that will prompt “skyrocketing” agricultural prices worldwide, exacerbate a decline in the dollar and quicken inflation, investor Jim Rogers said.

The “clowns in Washington” have “signaled to the world they don’t care about the U.S. dollar,” Rogers said in an interview from Singapore. The Fed reduced its benchmark rate by half a percentage point to 4.75 percent last week.

The commodities rally, which Rogers correctly predicted in 1999, may last 15 more years, he said. Oil may reach $150 a barrel during that time, Rogers added. In 2005, he said the commodity bull market may last until 2022 because of a lack of investment during the past two decades.

Rogers, 64, co-founded the Quantum hedge fund with George Soros in the 1970s and traveled the world by motorcycle and car in the 1990s researching investment ideas for his books, which include “Adventure Capitalist” and “Hot Commodities.”

The dollar today fell to a record against the euro and weakened versus the yen on speculation U.S. growth is losing momentum, adding to pressure on the Fed to reduce interest rates again. The currency’s slide has boosted gold as investors seek an alternative investment, lifting prices to the highest since 1980.

Crude oil has surged 32 percent in the past year, and last week reached a record $83.90 a barrel in New York. Wheat set an all-time high of $9.1125 a bushel on Sept. 12 as world consumption is forecast to exceed production for the seventh time in eight years.

`Place to Be’

On July 2, Rogers said agricultural commodities were “the place to be,” and that investors should buy them over stocks and bonds. Today, he advised against buying wheat, which has become the most expensive ever relative to corn, soybeans and cotton.

“I wouldn’t buy it now,” Rogers said. “If you’re going to buy something, buy coffee or cotton or sugar. Wheat has been going straight up for about a year. I don’t like to jump on a moving bus.”

Prices will fall 30 percent to $6 a bushel within a year, said James Gutman at Goldman Sachs Group Inc. in London and Pierre Martin, manager of a $490 million commodity fund at DWS Investment GmbH. Chicago futures markets show a similar drop.

The Standard & Poor’s 500 Index today lost 8.02, or 0.5 percent, to 1,517.73 after the International Monetary Fund warned of “protracted” economic instability.

To contact the reporters on this story: Betty Liu in New York at bliu17@bloomberg.net ; Eric Martin in New York at emartin21@bloomberg.net .

Last Updated: September 24, 2007 16:19 EDT

Structured Finance and the Outlook for the Dollar

Fri, Sep 14 2007, 13:55 GMT
by Jay H. Bryson

Danske Bank A/S

(in fxstreet.com)

Recent dislocations in credit markets have caused issuance of structured fixed-income products to decline significantly. Although new issuance will not likely remain at today’s depressed levels forever, few observers expect it to return to the heady pace of early 2007 anytime soon. Therefore, foreign investors, who have been avid buyers of U.S. structured products over the past few years, will not have as many fixed-income securities to purchase in the United States.

Could foreigners shift out of structured products into more traditional securities like Treasury, agency and corporate bonds? Perhaps, but the recent decline in U.S. yields has eroded the relative attractiveness of those more traditional securities. Therefore, it seems likely that net capital inflows, which are needed to finance the gaping current account surplus, will weaken further, thereby putting downward pressure on the dollar. Indeed, we project that the greenback will depreciate further vis-à-vis most major currencies in the quarters ahead.

Foreign Investors Have Been Large Buyers of U.S. Structured Products

Credit markets have become volatile over the past month or two due to the well-publicized problems in the U.S. subprime mortgage market. Because most subprime mortgages are securitized, structured products have been the most adversely affected fixed-income asset class. For example, new issuance of asset-backed securities (ABS) has plunged precipitously over the past few weeks (Exhibit 1). Although new issuance will not likely remain at current depressed levels forever, few observers expect it to return to the heady pace of early 2007 anytime soon.

Not only have domestic investors been willing participants in structured fixed-income markets over the past few years, but foreigners have also bought significant amounts of these securities. Exhibit 2 shows estimates of foreign purchases of U.S. long-term securities by type.1 Foreign purchases of U.S. long-term securities totaled nearly $1.2 trillion between July 2005 and June 2006.2 In that 12-month period, we estimate that foreigners bought about $200 billion of agency ABS and nearly $270 billion of corporate ABS.3 Moreover, purchases of ABS represent about 40% of total foreign purchases of U.S. securities during the past two years. Although we readily admit that the estimates our methodology gives us in Exhibit 2 may not be completely reliable, we believe it is reasonable to claim that foreigners have purchased significant amounts of structured fixed-income products over the past few years.

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Legal disclaimer and risk disclosure

This publication has been prepared by Danske Bank for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Bank’s research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Bank A/S is regulated by the FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright () Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.

August 29, 2007

Calls Grow for Foreigners to Have a Say on U.S. Market Rules

By HEATHER TIMMONS and KATRIN BENNHOLD

Politicians, regulators and financial specialists outside the United States are seeking a role in the oversight of American markets, banks and rating agencies after recent problems related to subprime mortgages.

Their argument is simple: The United States is exporting financial products, but losses to investors in other countries suggest that American regulators are not properly monitoring the products or alerting investors to the risks.

“We need an international approach, and the United States needs to be part of it,” said Peter Bofinger, a member of the German government’s economics advisory board and a professor at the University of Würzburg.

While regulators in the United States have not been receptive to the idea in the past, analysts said that Europe and Asia had more leverage now. Washington might have to yield if it wants to succeed in imposing bilateral regulations on government-owned investment funds from emerging economies.

“America depends on the rest of the world to finance its debt,” Mr. Bofinger said. “If our institutions stopped buying their financial products, it would hurt.”

Half a dozen American banking and financial regulators — including the Securities and Exchange Commission and the Federal Reserve Board — had no comment. Several noted that they were not the sole regulators of the subprime market.

In general, Washington’s reaction has been that it wants “no form of oversight,” said Kenneth Rogoff, an economics professor at Harvard and a former chief economist of the International Monetary Fund.

Banks and investment funds from China to France suffered losses after buying mortgage-related securities and complex financial products based on them in the United States.

In many cases, investors were caught by surprise because American rating agencies had given the products top ratings, leading buyers to believe there was little risk. International investors are also asking why American lenders were allowed to give mortgages to home buyers who could not repay them.

“In a globalized economy with hedge funds, leveraged buyouts and all these investment funds, we have to ask the question about more transparency,” said Claude Bébéar, the chairman of the supervisory board of the insurance company AXA.

In Europe, the credit crisis appears to have emboldened those who have long been pushing for stricter international rules.

Washington and London rebuffed the German government earlier when it pushed for an international code of conduct for hedge funds. Now some economic advisers to the German government are going further, suggesting that rating agencies should be nationalized, that large-scale loans be registered publicly and that minimum standards be developed for complex debt securities.

The head of the Council of Economic Analysis in France, which advises the prime minister, said hedge funds should be subject to stricter disclosure rules about their risk exposure.

Christian de Boissieu, president of the group and a member of the Committee for Credit and Investment Institutions, which helps regulate French banks, is calling for a global register of hedge funds. In addition, he said, complex securities should be scrutinized before being sold to bank portfolios.

President Nicolas Sarkozy of France, who has vowed to “moralize financial capitalism,” has asked his finance minister, Christine Lagarde, to prepare a proposal for stricter disclosure rules on market participants before an October meeting of finance ministers from the Group of 7. On Monday, in a foreign policy speech, Mr. Sarkozy called again for stronger global regulations to avoid financial crises.

The Chinese central bank said yesterday that it was moving to standardize disclosure of all asset-backed securities as it increases its own market for the financial instruments. Information about loans, terms and borrowers will need to be included in any new securities in China, it said.

The United States and Britain are the source of the bulk of the world’s sophisticated financial products, like the ones that broke down recently.

“At the heart of the issue is that the largest financial institutions continue to innovate and create ever more sophisticated products,” said Chris Rexworthy, director of enhanced regulatory services at IMS Consulting in London and a former regulator with the Financial Services Authority in Britain.

Regulators talk about the importance of stress-testing, Mr. Rexworthy said, but recent developments create concerns that “institutions are either not investing enough effort in this, getting it wrong, or just producing things too complex for their risk-assessment models to cope with.”

“Greater cooperation on the international stage between regulators is undoubtedly one of the things we need to see more of.”

United States regulators are aware of the problem. Regulators have found that credit standards were loosened for home loans, and that borrowers in some cases did not understand or qualify for the loans they were given.

Treasury Secretary Henry M. Paulson Jr. said in June that the department was seeking better oversight, increased efficiency and a reduction in overlap in general.

Some American regulators have been pushing for more international cooperation. The Securities and Exchange Commission has been discussing greater oversight of hedge funds, and it signed several cooperation agreements with regulators from China to Germany in the last 18 months.

The S.E.C. understands “the need for closer international cooperation,” said Andrew Larcos, the public affairs officer for the International Organization of Securities Commissions, the global regulatory body.

Still, Mr. Larcos added, because the subprime mortgage loans that started the crisis were primarily from the United States, the situation obviously raises questions about market regulation.

In the United States, much of the focus is on rating agencies, which are paid by banks for rating products, and which sometimes attached investment-grade ratings to securities that turned out to be not up to that standard.

Joseph Mason, a finance professor at Drexel University in Philadelphia, and Josh Rosner, the managing director of the research firm Graham Fisher, have pushed for more oversight of rating agencies.

“It’s not just the U.S. regulators that failed, though they did fail,” Mr. Rosner said. International regulators have “thrown the keys to the rating agencies,” which have been left in charge of the safety and soundness of bank capital, insurance and pension money.

In Australia, where investors have embraced financial products like derivatives and swaps, several hedge funds were hard hit by exposure to subprime loans, and analysts said they expected it would be months before the extent of the problem became clear.

As geographical boundaries are broken down, “a problem in one location is a problem everywhere,” said Dick Bryan, a professor of economics at the University of Sydney.

“There is the need to challenge the sovereignty of national regulators,” he said. “Why should the rules of lending in the U.S. be left to U.S. regulators when the consequences go everywhere?”

Asian nations were pushing for regional cooperation even before the latest credit problems, as cross-border investing and their equity markets have boomed.

Whether the outcry will result in changes remains to be seen. Soon after the 1997 Asian financial crisis, President Bill Clinton and a number of regulators and politicians pushed to remake the global financial system. But the impetus faded as markets stabilized.

Economists now expect an increase in international regulation, particularly because Washington has raised questions about the need to impose standards on large investment funds controlled by countries like Russia and China.

Ms. Lagarde, the French finance minister, predicted that negotiations might indeed succeed. “There are a lot of shifts happening,” she said. “Once the dust has settled we will see where the different powers stand and what will be on the bargaining table.”

http://www.nytimes.com/2007/08/29/business/worldbusiness/29regulate.html?

ei=5087%0A&em=&en=f5581730440849aa&ex=

1188619200&pagewanted=print

http://online.wsj.com/article/SB118817290004309347.html 

Pension Managers Rethink
Their Love of Hedge Funds

By CRAIG KARMIN
August 27, 2007; Page C1

Many public pension funds in recent years have become eager to invest in hedge funds. Now, some are getting cold feet.

Pension-fund managers from Louisiana to Ohio are saying they may slow their push into these funds after the recent losses suffered at big hedge funds — including ones run by Goldman Sachs Group Inc. and AQR Capital Management — have reinforced some of the risks.

Indeed, one critic suggests that pensions would be foolish to keep pursuing hedge funds. “It’s like planning a vacation to an exotic land, and finding out that there’s an outbreak of bubonic plague,” says Frederick Rowe, chairman of the Texas Pension Review Board, which provides oversight of Texas public pension funds.

It’s a significant reversal in thinking. Less than a year ago, more than 42% of public pension funds said they were planning “significant increases” to their existing hedge-fund investments, according to the consulting firm Greenwich Associates. At least 20 public pension funds are taking steps toward investing in hedge funds for the first time, based on research prepared by Financial Investment News.

The Ohio School Employees Retirement System, for one, says it can invest up to 10% of its $11.7 billion in assets in hedge funds and that it has already hired a consultant to find some funds. “But recent events have given us some more things to think about,” says Jim Winfree, executive director. “We are going extremely slowly.”

It may be too early to see any pension funds redeeming their hedge-fund holdings, and some of the hardest-hit hedge funds have already shown signs of rebounding. But pension managers say the erratic moves in recent weeks are reason enough to worry most pension-fund boards.

Any pullback by pension funds would be a blow to many hedge funds, which are increasingly relying on these funds as a way to raise large amounts of capital.

For their part, pension plans — which were among the investors burned by the bear market of 2000-2002 — took note that many hedge funds provided some protection back then. As a result, in the past few years, many have started shifting into hedge funds and other alternative investments as a way to shield against a similar downturn in the future.

Yet Kevin Lynch, a managing director at the consulting firm RogersCasey in Darien, Conn., says he noticed a palpable difference recently when discussing hedge funds with pension-fund managers “They’re all kind of spooked,” he says.

Allan Bentkowski, investment manager for the $700 million Tucson Supplemental Retirement System, said representatives from J.P. Morgan Chase & Co. visited their Arizona offices last year to discuss the merits of hedge funds. But after recent volatility, “the board has no inclination at this point.”

At the Teachers’ Retirement System of Louisiana, Phil Griffiths, the deputy chief investment officer, says he invested $25 million in a hedge fund last year and has the ability to move another $125 million of his $15.4 billion in assets into hedge funds.

But before he invests in any more hedge funds, he is waiting until at least the end of next month to see how some of the funds performed and whether they were hit with redemptions.

“If the funds didn’t fare well, we’d see that as a negative,” Mr. Griffith says. “Those results will probably prompt us to go one way or the other.”

Other pension funds say plans to begin investing in hedge funds could be delayed. The Ohio Police and Fire Pension Fund says it has already selected two hedge funds to manage a combined $300 million in a strategy known as global macro, in which funds invest in a variety of assets around the world. But it has paused before formally committing that money.

“We are checking in with our global macro managers far more frequently than normal,” says William Estabrook, executive director at the $12.6 billion fund.

This doesn’t mean all pension funds have turned more cautious. Many say they are long-term investors and that despite some losses, hedge-fund investments over time will lift returns and diversify a portfolio because they usually don’t move in lockstep with stocks and bonds.

The board of the California Public Employees’ Retirement System, with $243 billion in assets, recently said the pension fund could raise its hedge-fund investments to $12 billion from $5 billion.

The San Diego County Employees Retirement Association, which has 12 separate hedge-fund investments, lost $80 million when Amaranth Advisors collapsed in 2006, though the fund still returned 16% for the year ended in June. The San Diego fund also held positions in funds from AQR and D.E. Shaw & Co. that hit rocky patches in recent weeks.

Still, “we are looking at adding hedge-fund managers,” says Brian White, the chief executive officer. “This reinforces the rule that diversification is good.”

Dan Gallagher, chief investment officer at the Los Angeles City Employees’ Retirement System, suggests the hedge-fund losses have only made him more skeptical. “I’m not a major hedge-fund proponent,” he says. “And the perception among some of our trustees is that hedge funds are very volatile and that there is risk there.”

Write to Craig Karmin at craig.karmin@wsj.com

What’s Offline

Praising Private Equity

PAUL B. BROWN

Published: August 25, 2007

THE conventional wisdom is that private equity firms are focused strictly on the short term.

The conventional wisdom is wrong, argues Walter Kiechel III, the former editorial director of Harvard Business School Publishing.

True, he concedes, private equity firms often load debt onto the public companies they acquire, sell off assets and then dispose of the acquired business in a relatively short time.

But what is really going on, he contends in The Harvard Business Review, is that private equity firms are simply applying, albeit very quickly, the best of classic strategic thinking, and their actions can actually improve the acquired company’s long-term performance. The fact that a private equity firm sells the company within a relatively short period is irrelevant.

Mr. Kiechel says the important thing is to look at the actions of the private equity firms. By using leverage efficiently, relentlessly cutting costs and determining the company’s major competitive advantage — and disposing of all assets that do not support it — they are actually positioning the companies they are acquiring to succeed for the long haul.

“The difference between the conventional and the P.E. approach to strategy is that the private equity buckoes put their acquisitions through the formulate-a-strategy-and-start-implementing-it process in months rather than years,” he says.

MORE GOVERNMENT BENEFICIARIES The opening sure does get your attention.

“More than half of all Americans — 53 percent — now depend on government for their income,” Katherine Mangu-Ward writes in Reason.

The research comes from the economist A. Gary Shilling, who totaled “federal, state, and local government workers, plus private-sector workers who owe their jobs to the government, plus recipients of Social Security, other transfer payments and benefits such as food stamps.” As startling as that 53 percent figure is, it is not a record high. In 1980, 55 percent of Americans were receiving money from the government in one form or another.

CUTTING DEBT “Two-thirds of all college graduates in America leave school with student loan debt — to the tune of $20,000 on average,” Lynnette Khalfani writes in BeE Woman, a relatively new magazine.

Depressing though that can be, Ms. Khalfani outlines the following five strategies to reduce or eliminate that indebtedness:

¶Negotiate. The interest rate on federal student loans is not an absolute. While Congress sets a maximum rate, lenders are free to charge less. “Ask for a lower rate in exchange for having payments automatically deducted from your checking and/or because you have a history of paying on time,” she suggests.

¶Make the boss pay. Many employers will do so, Ms. Khalfani says, if you agree to stay with the company for a certain amount of time.

¶Work for the federal government. Under the Federal Student Loan Repayment Program, a federal agency can pay off up to $10,000 of your student loan annually, up to a maximum of $60,000.

¶Cite hardships. Sallie Mae, the nation’s biggest student lender, offers deferments for “nearly 20 different scenarios,” she says. Stay-at-home mothers with babies, new mothers re-entering the work force, the unemployed and military enlistees all qualify, she says.

¶Do good. Police officers, lawyers, teachers, nurses and doctors can have their loans forgiven, under certain conditions.

FINAL TAKE This comes courtesy of Money magazine, citing research done by Capital One: “More Americans use a piggy bank (42 percent) or change jar (65 percent) than a money market account (35 percent.)”

PAUL B. BROWN

http://www.nytimes.com/2007/08/25/business/25offline.html?ref=business 

The Long View: Why the world still waits on Wall Street

By John Authers, Investment Editor

Published: August 10 2007 16:22 | Last updated: August 10 2007 18:49

Here is a paradox. The world’s economy is steadily “decoupling” from the US. The extent of the effect can be overstated, but it is plain that a new engine of growth is rising, in China and India, and that the importance of the US thereby diminishes.

And yet there is no such decoupling of world markets. Quite the reverse. I have commented on this paradox before, but the panic-driven volatility of the past month has made it even more glaring.

For stretches over the last few weeks, it has been as though the only market that mattered in the world was in New York. The huge and growing bourses of Europe and Asia seemed powerless to do anything more than react to the latest swing on Wall Street, that had happened as they slept. How can we explain this?

The evidence for some economic decoupling, despite the forces of globalisation, grows stronger. The US is at a different point in the cycle to anywhere else in the developing world. This Tuesday’s statement from the US Federal Reserve, brought the bank closer to cutting its benchmark Fed Funds rate, which has been on hold at 5.25 per cent for more than a year.

Contrast this with the UK, which suffers the most entrenched inflation expectations in the developed world, and where the Bank of England’s latest inflation report increased the chances of another rate rise. Or with the eurozone, where the European Central Bank has virtually promised that it will raise rates once more next month (even as it has resorted to intervention in the market to maintain liquidity).

In Asia, Korea’s central bank this week surprised the markets with an interest rate rise, to 5 per cent – its highest level since 2001. Australians also had to contend with a rate rise, though that was less surprising. In emerging markets, particularly China, the challenge is to rein in rampant growth.

So if the US is still the world’s consumer of last resort, it has a strange way of showing up in the data.

However, Wall Street seems ever more central to the world’s capital markets. A look at minute-by-minute price movements in the S&P 500 and the FTSE-100, the main benchmarks for New York and London, over the last two weeks, allows no other conclusion.

The two lines look much the same. They have risen and fallen together as global markets have responded to the steady flow of news about the US subprime mortgage crisis. But the FTSE is punctuated by gaps.

Day after day, Wall Street saves its decisive move until after European markets have closed. The FTSE (and other European indices) respond by “gapping,” to use the market argot. In other words, there is a break in the continuous flow of prices. Instead, prices are simply marked drastically up or down at the opening in London, in an attempt to catch up with Wall Street.

Why does Europe follow Wall Street’s lead so slavishly when its economies seem to be at a different stage in the cycle?

Globalisation has something to do with it. Standard & Poor’s companies increasingly draw revenues and profits from outside the US. FTSE companies are even more international. For large companies, at least, the country where they are listed is becoming less and less relevant to their share price performance.

But more importantly, markets themselves are more international, with technology making it easy to trade across asset classes, and across continents. It makes less sense to talk about coupled markets than to refer to one, ever more homogeneous market. The US still has the world’s largest economy so it will be the major force.

Finally, the sole factor that is driving world market volatility emanates from the US. The debacle of subprime mortgages, made to people with poor credit histories, is a US problem. Globalised markets have allowed companies in Australia, France or Germany, to share in the losses.

But the greatest fears attach to the big US banks and hedge funds, and to the health of the US financial system. The subprime sell-off might yet quite easily prove to be a healthy correction, but it might also turn into a full-blown systemic crisis.

That in turn could happen if liquidity dries up in US markets, or if a big US institution collapses. Hence huge swings in the Wall Street afternoon as traders, who are in any case very close to the institutions allegedly at risk, respond to the latest rumour.

It is a sad state of affairs for the US. Once the fulcrum of world markets because it was the engine of global growth, it now holds that position because it is the epicentre of global risk.

Recent weeks should also dampen triumphalism in London over its growth as a financial centre. It is in vogue to describe London, without caveat, as the world’s “financial capital”.

The City of London hosts many more transactions than it did a decade ago. This has generated great wealth for the city, and for the UK. But we can see from the last weeks that London’s role in global markets is still essentially passive. The decisions, and the trades, that determine whether the summer credit crunch turns into a full-blown crisis will be made in Manhattan, not the Square Mile.

john.authers@ft.com

Copyright The Financial Times Limited 2007

http://www.ft.com/cms/s/6cbd6716-4747-11dc-9096-0000779fd2ac.html