By WILLIAM PESEK
Barron’s Asia
June 8, 2016

Goldman Sachs finds itself ensnared in the 1MDB scandal which threatens to squeeze the nation’s credit rating.

Goldman Sachs is sharing its giant vampire squid with Najib Razak’s government in Malaysia.

The investment colossus has found itself at the scene of many a scandal – a financial Forrest Gump, if you will. From U.S. Treasury bidding probes to Greece’s debt crisis to the subprime meltdown, Goldman’s bankers were there reaping fortunes behind the scenes. In a 2009 Rolling Stone piece, Matt Tiabbi famously branded it “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

Make that Malaysia, too. As the Wall Street Journal reports, U.S. officials are probing whether Goldman broke the law by not alerting authorities about dodgy dealings at state investment fund 1Malaysia Development Bhd.

It’s the latest reminder of how Prime Minister Najib’s 1MDB mess is wrapping its tentacles around an entire nation. The unpredictable ways in which it threatens to drag Southeast Asia’s third-biggest economy under, like some massive vampire squid, can be seen in Putrajaya’s balance sheet. Could it even lead to a credit downgrade?

Yes, argues Sian Fenner of Oxford Economics in Singapore. Malaysia’s total government debt, she reckons, ended 2015 at 54.5% of gross domestic product, a heavy burden relative to Asian peers. As Najib dismantles the debt-ridden 1MDB he created in 2009, his government may have to assume some liabilities. According to Fenner’s calculations, that could top 2.5% of GDP. “We find that it would have a material effect on asset prices and pressure on the exchange rate could see Bank Negara raising interest rates to support the currency despite weaker domestic activity,” she says.

In March, Fitch warned a downgrade was “more than 50 percent likely” as 1MDB struggled to meet obligations and the trade balance darkened. Last month, 1MDB defaulted, adding to what traders call “headline risk.” At the same time, corruption probes in at least seven countries are intensifying even as Najib’s government insists the case is closed. Hardly, with overseas investigators sniffing around to locate more than $6 billion of funds believed to be unaccounted for. And as the Wall Street Journal alleges, investigators are all over hundreds of millions of dollars Najib and his family may have used to finance everything from real estate to jewelry to Leonardo DiCaprio’s “Wolf of Wall Street” film.

Sadly, Putrajaya’s response has been to circle the wagons and blame the messenger. Najib recently said his central bank directed the police to investigate foreign media outlets breaking news on 1MDB. That’s an ominous sign for the state of central-bank autonomy in Kuala Lumpur. As I wrote last month, there are questions about whether new Governor Muhammad Ibrahim can maintain the same independence as predecessor Zeti Akhtar Aziz.

Far from boosting Malaysia’s economy, 1MDB is denting its standing as global headwinds intensify. Last week, Credit Suisse became the latest investment bank – joining JP Morgan and others – in downgrading Malaysian shares. Along with “considerable political and governance risks,” Credit Suisse cites oil-price trends and an economy that “remains subject to negative growth revisions and a weak consumer.”

This circles back to Fenner’s view. Since late 2009, she says, the share of debt held by foreigners has more than doubled, and amounted to more than a third of total debt at the end of the first quarter. The drip, drip, drip of bad news since then only increases Malaysia’s vulnerability to shifts in investor sentiment. “While at these levels debt is still manageable, there are several factors that have increased Malaysia’s vulnerability,” Fenner warns.

One is how a government in full survival mode isn’t restructuring an economy falling further behind. Early in his premiership that began in 2009, Najib pledged to scale back the affirmative-action polities benefiting the ethnic-Malay majority. That scheme, implemented by Najib’s prime minister father in the early 1970s, kills productivity, deadens innovation and encourages multinational companies to set up shop in Singapore, Indonesia and Vietnam instead of Malaysia.

Another is how Najib’s party, which has held power since 1946, is neutering government institutions to extend its reign. Case in point: a proposed overseas travel ban on Malaysians who criticize the government. The assault on the media, both domestic and foreign, is troubling, too. For a reality check, I recommend reading Wall Street Journal reporter Tom Wright’s interview with Mustapha Kamil, who recently resigned from New Straits Times newspaper to protest “authoritarian” winds coursing through officialdom.

The more Malaysia obfuscates on 1MDB, the more outside parties pounce. It was truly surreal to see Najib hosting Asia’s World Economic Forum in Kuala Lumpur last week, pretending all’s well in his economy. U.S. law enforcement officials scheduling interviews with Goldman executives (according to the Journal) would disagree. At issue is the U.S. Bank Secrecy Act, which demands financial institutions flag suspicious transactions. It should worry Najib’s team that a law employed to snag Ponzi-schemer Bernard Madoff is looking their way.

It should worry investors that 1MDB’s tentacles are wrapped so tightly around what should be one of Asia’s most vibrant economies. With vast natural resources, 30 million people and enviable proximity to China and India, the place should be thriving. Yet it’s run by a party putting its own interests ahead of the masses. And now, Najib’s creature is squeezing Malaysia’s credit rating. No wonder investigators and investors alike have that sinking feeling.