Where does the money come from? How do they work? Are these things good for America?

Sovereign wealth funds have been in existence since the 1950s, but their growing prominence in recent high-profile transactions has many people questioning them and asking ‘Is America up for sale to them?’

To set the scene, Citigroup, a major American financial services company that operates Citi Bank, was hit hard by the credit crisis last fall. The bank was looking for help to cover its losses and stay in business, when it found a generous capital influx from the-mother-of-all-sovereign-wealth-funds, Abu Dhabi. Without the last minute help from Abu Dhabi, Citi would have had some major problems. But what does this mean for Americans?

All countries operate foreign exchange reserves where they keep a healthy amount of foreign currencies. In some countries, usually the rich, oil-producing ones, there is a large surplus of these foreign monies. The surplus monies are then pooled into a fund that is managed to make investments where it sees fit. These are the famous/infamous sovereign wealth funds.

In 1990, these funds combined had something like $500 million, which isn’t too much to brag about, but in recent years that number has grown to over $3 trillion. That’s a lot of American dollars that would be wasted if they weren’t spent in America.

Abu Dhabi, located in the United Arab Emirates, is the largest of the major sovereign wealth funds with a total of $875 billion. Following behind them is the second largest, Norway’s Government pension fund with $380 billion. The third largest is the Government of Singapore Investment Group with $330 billion.

Robert Kimmit, America’s Deputy Treasury Secretary, answered some questions from Alexis Glick on Fox Business last week about the rising influence of these massive Sovereign Wealth Funds. He stood strong on saying they were good for Americans:

Foreign direct investment creates American jobs. 5 million Americans work for companies headquartered overseas. 40% of those jobs are in manufacturing, whereas only 13% of the overall economy is in manufacturing and for every $10 million of new investment, 30 direct and 30 indirect jobs are created. So foreign direct investment, whether it be from sovereign wealth funds or elsewhere, creates good American jobs.

There are other factors to take into account, however. Currently, these sovereign wealth funds (SWFs) don’t need to disclose much information to the public about what other investments they are undertaking, their assets or their liabilities. Many fear they may be operating under the fast and loose hedge fund rules which include making investments that garner higher returns but also come with much higher risks. And when such large sums of money are involved, that could be a potential disaster.

The solution to this, which Kimmit touched on in his interview, is the need for increased regulation and oversight on these SWFs. With regard to the demand for tougher standards of control, Kimmit says these guys are all on board:

All the sovereign wealth funds are participating and again they are saying, yes, we want to be transparent. We want to have good corporate governance and good risk management. We have for 55 years invested for commercial purposes. We want to show you that we are going to continue to do that.

So obviously he’s a big fan of them. And given the points he uses, maybe he should be. There are alarming signs to look out for, though. If more and more U.S. and European banks are asking for help and a little extra cash to keep ’em going, the SWFs will be waiting on deck to step up to the plate. Pretty soon, will we realize that many of our American companies are partly owned by these SWFs? Or worse, will we realize it too late?

Let us know in the comments section your opinion on whether the SWFs are offering some much needed help or if we should be increasingly wary of them.

Fox Business: Opening Bell with Alexis Glick, April 15, 2008

The Times Online: Citigroup writes off another $15.2 billion, April 19, 2008

International Monetary Fund: The Rise of Sovereign Wealth Funds, September 2007