UPDATE 2-US Treasury says don't restrict wealth funds

(Recasts first paragraph; adds background)

By Glenn Somerville

WASHINGTON, Feb 13 (Reuters) - A senior U.S. Treasury Department official warned on Wednesday that Congress risks retaliation against U.S. companies overseas if it proposes laws to force sovereign wealth funds to disclose more about the purposes of their U.S. investments.

However, the chairman of the congressional Joint Economic Committee said with Middle Eastern and Asian wealth funds taking huge stakes in companies like Citigroup (C.N), Morgan Stanley (MS.N) and Merrill Lynch MER.N, concern was rising about the impact on the U.S. economy and to national security.

JEC Chairman Sen. Charles Schumer said if the International Monetary Fund does not quickly come up with a voluntary code of conduct for wealth funds, Congress will consider legislation to ensure the funds' operations and intentions are made transparent.

"The question of the day is whether these huge pools of investment dollars, known as sovereign wealth funds, make the U.S. economy stronger or pose serious national security risks," Schumer said.

The Treasury's top diplomat, Undersecretary for International Affairs David McCormick, said the wealth funds can be a stabilizing factor by helping recirculate investment funds and cautioned about the potential impact of restricting them.

"If the United States imposed new restrictions, other countries could impose restrictions on U.S. investors, jeopardizing the benefits generated in the United States by U.S. businesses that operate globally," McCormick said in prepared remarks.

Citigroup raised about $12.5 billion this year after announcing a record quarterly loss of nearly $10 billion. The infusion includes nearly $7 billion from Singapore Investment Corp Pte, and $3 billion from the Kuwait Investment Authority.

Merrill Lynch & Co. Inc., which had a third-quarter loss of $2.3 billion and $8.4 billion in write-downs, said it received a $6.6 billion investment from Kuwait, the Korean Investment Corp and Japan's Mizuho Financial Group Inc (8411.T).

In December after recording a fourth-quarter loss and $9.4 billion of write-downs, Morgan Stanley said it sold a $5 billion stake in itself to China Investment Corp.

McCormick said Treasury wants the IMF, with support from the World Bank, to develop a code of best practices for sovereign wealth funds, which would provide guidance on how they should be structured to reduce systemic risk.

The funds, many of them in the Middle East but also in Russia and China, have arisen because high oil prices and the huge U.S. trade deficit have led to the accumulation of assets that are being reinvested in the United States.

McCormick said 20 new funds have been created since 2000, more than half of them since 2005, bringing the total to nearly 40 funds with total assets between $1.9 trillion to $2.9 trillion. The Treasury said estimates were they will swell to $10 trillion to $15 trillion by 2015.

While he acknowledged the funds' activities raise concerns, McCormick said a main worry was that Congress would pass laws retaliating against them and choke off a source of foreign investment.

McCormick said sovereign wealth funds "are, in principle, long term, stable investors" that offer substantial benefits for the United States and are unlikely to be disruptive.

"They are typically not highly leveraged and cannot be forced by capital requirements or investor withdrawals to liquidate positions rapidly," he noted, which makes them a stabilizing force in the economy.

During questioning, Schumer expressed doubt about the value of the screening process that is used to ensure foreign investments pose no threat to national security.

Congress strengthened the laws last year after the inter-agency Committee on Foreign Investment in the United States, called CFIUS, approved the acquisition of several U.S. port operations by state-owned Dubai Ports World.

The new law requires CFIUS to spend more time vetting deals and to keep Congress better informed.

"It's still an opaque government panel led by Treasury," Schumer said. But McCormick said it was hard to make the process more open while deals were being negotiated.

"The more that the deliberations are open, there is more a risk of the decision being politicized," McCormick said. (Additional reporting by Rachel Younglai; Editing by Neil Stempleman