Many of the world’s largest sovereign funds believe that they were taken to the cleaners earlier this year when they dumped billions of dollars into large US financial companies like Citigroup (C) and Merrill Lynch (MER). They got to watch the value of their investments drop 50% or more as the credit crisis got worse.

After all of that, it was fair to assume that countries from China to Singapore to Abu Dhabi would not be sending analysts to the America to kick the tires of banks with plans to put good money after bad.

The FDIC may have given the sovereigns good reason to come back to the horse trough. The agency will be insuring new senior notes issued by some of the country’s financial firms. According to Bloomberg, "The Bush administration will announce a broad plan to rescue frozen credit markets that includes buying stakes in financial institutions and insuring some bank debt for three years."

The move is exceedingly clever. It will allow Treasury to keep some of the Paulson plan’s $700 billion in reserve for emergencies and for buying toxic paper and probably cut the investment it will have to make in preferred shares of banks.

Sovereign funds have assets which are substantially greater than the capital the Treasury is being allowed to deploy. Singapore’s Tamesak fund controls more than $131 billion. Estimates of the size of the The Abu Dhabi Investment Authority almost all put it above $250 billion. The Times of London recently reported that total sovereign fund assets may be more than $12 trillion by 2012.

Until recently, legislators and regulators in the US and EU were trying to restrict sovereign fund activity due to fear that investments might be made for political and not financial reasons. Some of those actions alienated the largest funds.

Now, the US is desperate to get the big money to come back and the FDIC has offered the perfect bait.

Douglas A. McIntyre

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