Why foreigners invest in U.S. markets

One factor behind the U.S. government's decision to take over troubled mortgage companies Fannie Mae and Freddie Mac? Concerns expressed by foreign investors, The Wall Street Journal reports. That brings to mind a new working paper by MIT Sloan School associate professor Kristin J. Forbes.  She studied the question of why foreigners continue to invest in U.S. markets even though their returns over the 2002-2006 period were far lower than Americans' returns on investment abroad.  Such nondomestic investment plays an important role in the current U.S. economy — with foreigners investing an average of more than $5 billion every day in the U.S., according to Professor Forbes.

Forbes' analysis leads her to the conclusion that foreigners are more likely to invest in the U.S. if their own country's capital markets are not as well developed as American ones. That finding suggests that, as other countries gradually improve their domestic financial markets, they will over time invest less in the U.S. That shift would likely be gradual, Forbes writes — with one caveat: Since the perceived liquidity and efficiency of American financial markets is an important factor driving foreign investment here, anything that undermines that perception could risk the stability of those ongoing capital inflows into the U.S.

Small wonder, then, that the U.S. Treasury department took foreign officials' concerns about Freddie Mac and Fannie Mae so seriously.