A Saudi Dump of U.S. Assets Will Only Hurt the Saudis
As President Obama visits Riyadh, U.S.-Saudi relations have been further strained by the Saudi government's threat to dump its American assets if Congress passes the Justice Against Sponsors of Terrorism Act - a bill that would allow families of 9/11 victims to sue the Saudi government. King Salman's threat was taken so seriously that the Obama administration has been lobbying Congress to block the bipartisan bill endorsed by the two Democratic presidential candidates.
Contrary to what the Saudi king and many Americans think, U.S. financial markets would do just fine if the Saudis followed up on their threat. If there is to be a victim of the "Saudi dump," it would be the Saudis themselves. What King Salman is really threatening is to shoot himself in the foot if Congress disregards his wishes. Congress should laugh the threat off.
The asset dump would require the Saudis to engage in large "block" trades. Over the years, economists have shown that these sizable transactions can lead block-sellers to lose some money in the short run, but that they have little effect on prices in the medium or long run. In 1997, for example, the Kuwaiti government suddenly sold a $2 billion block - or 3 percent - of British Petroleum (BP)'s shares within one day, in an attempt to rebalance Kuwait's own financial portfolio. Even though the abrupt sale was a record-breaking block trade, its impact on BP's share price was only small and temporary. After closing down 2.6 percent on the day of the big sale, BP's stock largely recovered in two weeks. Of course, Kuwait paid a price for cashing out in a hurry - about 2.6 percent of the holding value of those shares. The Kuwaiti sale was no coincidence; it's a testimony to how an efficient market handles block trades.
As early as 1972, Myron Scholes - a Nobel Prize-winning economist known for his research in asset pricing - made a powerful discovery: In an efficient market, block trades move prices permanently only if they contain new information about the returns on the assets.
In an efficient market, assets are priced by all the returns they will generate in the future. The long-run price of a security would react negatively only if investors learned bad news about its future returns. Had Kuwait's sale been driven by its private information that BP's profits would decline, the mere fact that Kuwait was selling would have been an unfavorable signal to other investors in BP's shares. In that case, investors would have been less willing to buy BP's shares, driving down its long-run price. This was apparently not the case in 1997 - BP investors learned nothing bad about their holdings when the Kuwaiti government adjusted its own portfolio. Neither would it be the case with a Saudi asset dump. The only new information that might emerge should Congress pass the Justice Against Sponsors of Terrorism Act would be evidence about Saudi participation in the 9/11 attacks. That might be bad news for the Saudis, but it's not bad news for American assets.
There's no question that block trades could affect asset prices in the short run. What this means to the Saudis, though, is a huge loss on their part. When the Saudi government dumps its American assets, investors who are willing to buy may not have enough cash to absorb them all at once. Those assets will have to be sold with a bulk discount, pushing the prices down temporarily. It will take some time before other investors can raise enough funds, buy up those under-valued assets, and eventually "correct" the asset prices. If the share prices of U.S. assets dumped by the Saudis decline as much as the BP shares did when the Kuwaitis sold them, the Saudi government would realize a loss of about $20 billion - the cost of suddenly liquidating its alleged $750 billion in American assets.
King Salman is making the same kind of bet that people sometimes associate with the Chinese government who owns 20 percent of foreign-held U.S. Treasury securities. The Saudi king thinks that the threat of an asset dump is real. It's not. The Saudis could choose to lose a lot of their money by flooding the market, only to see share prices recover rapidly. They could also choose to spread the sales over a long period of time, which is even more of a yawner. In either case, Congress should do what it thinks is right about the bill without worrying about the Saudi nonfactor.