Blake Hounshell highlights a tidbit from Henry Paulson's new memoir that caught my attention as well.  According to Paulson, in the summer of 2008 Russia approached China to sell off their Fannie Mae and Freddie Mac debt.  This merited stories from Bloomberg and the Financial Times.  According to the FT:

Russia proposed to China that the two nations should sell Fannie Mae and Freddie Mac bonds in 2008 to force the US government to bail out the giant mortgage-finance companies, former US Treasury secretary Hank Paulson has claimed....

Mr Paulson said that he was told about the Russian plan when he was in Beijing for the Olympics in August 2008. Russia had gone to war with Georgia, a US ally, on August 8.

“Russian officials had made a top-level approach to the Chinese, suggesting that together they might sell big chunks of their GSE holdings to force the US to use its emergency authorities to prop up these companies,” he said.

Fannie and Freddie are known as GSEs or government sponsored enterprises.

“The Chinese had declined to go along with the disruptive scheme, but the report was deeply troubling,” he said. A senior Russian official told the Financial Times that he could not comment on the allegation.

The Russians deny the story in the Bloomberg story, but Ashby Monk points out the possible implications: 

Paulson’s report is pretty amazing. If true, it would appear that Russia was plotting economic warfare against the US during the summer of 2008; I don’t really know what else to call it. Their intention was to use their sovereign wealth to purposely weaken and damage the US economy. The fact that all this apparently occurred around the same time that Russia was engaged in a traditional war with Georgia, a US ally, lends some credibility to the idea.

This revelation–while unconfirmed–will not comfort those in the West that fear SWFs; it doesn’t help anybody if these funds are seen to be potential weapons of economic destruction…

Let's assume this is true for the sake of making life interesting.  There's still a few more pieces of data I'd like to have before drawing conclusions. 

Monk assumes that the Russians did this for geopoltical reasons. If memory serves, however, China and Russia were both concerned about protecting the value of their GSE debt.  Forcing the U.S. government to intervene would have helped protect their remaining holdings.  So this might have been an entirely commercial gambit. 

Second, this really isn't about sovereign wealth funds per se but about official holdings of U.S. debt and equities.  Some people think this is a real problem -- others don't.  Readers should provide their thoughts in the comments.

Third, the fact that the Russians thought the Chinese would go along with them on this says a lot about the delusions Russian leaders had during the Russian-Georgian conflict.  They really seem to have believed that China, other members of the Shanghai Cooperation Organization, and the rest of the Collective Security Treaty Organization  would be perfectly cool with Russia recognizing the independence of two secessionist states -- just because it would be an affront to the U.S.A.  Whoops.

This raises my provocative but closing point -- that the Russian-Georgian war might have been the best thing that could have happened for the bilateral relationship.  Despite all the doomsaying at the time, the conflict -- combined with Great Recession -- had a modest humbling effect on Russian ambitions.  The commodity bubble - which had fuelled Russia's economic growth and self-confidence for the past decade - popped in the summer of 2008.  The recognition of Abkhazia and South Ossetia abetted a capital outflow that had begun in reaction to the Russian government's heavy-handedness in picking winners and losers in the domestic economy.  These trends, if nothing else, likely highlighted the opportunity costs of continued bellicosity to Russian elites and Russian policymakers. 

At the same time, the invasion itself provided a moment of clarity to U.S. policymakers about the precise limits of their influence when dealing with balky republics in the Caucasus.  Even as a candidate, Obama articulated a "realist internationalist" position towards the Russian Federation.  This approach recognizes Russia's great power status and the utility of a great power concert in dealing with global trouble spots.  Rather than prioritizing human rights, democratization, or even economic interests in the bilateral relationship, this policy position prioritizes great power cooperation on matters of high politics, such as nuclear nonproliferation and the containment of rogue states that transgress global norms.

You can argue about the priorities, but on the whole I think this policy has worked.  The war allowed both sides to confront the costs of continuing down a very negative trajectory.  They both stepped away from the brink.

This is worth thinking about whem mulling over a different bilateral relationship that's had a bad few months.

When your agency is less popular than the federal institutions responsible for torture enhanced interrogation techniques, tax audits, and the requirement that you take your shoes off at the airport, you know you have a public image problem. 

So I wonder if the following news will help or hurt the Fed: 

The Federal Reserve has made a $14bn profit on loan programmes that have provided hundreds of billions of dollars in liquidity to the financial system since the start of the crisis two years ago, according to Fed officials.

The internal estimate is based on the difference between the fees and interest on the lending facilities and the interest the Fed would have earned had it invested the funds in three-month Treasury bills.

The central bank earned about $19bn in income from charging interest and fees to financial institutions and investors that tapped the new facilities to obtain much-needed funds during the turmoil. The interest the Fed would have earned by investing the same amount in T-bills was an estimated $5bn, leaving a $14bn gain since August 2007....

The calculation by Fed staff, which has neither been audited, published or risk-adjusted, only deals with its liquidity facilities.

Those include discount window and Term Auction Facility loans to banks, currency swaps with other central banks, purchases of commercial paper and financing for investors in asset-backed securities.

If I'm reading this right, this assessment does not include the Troubled Assets Relief Program (TARP).  According to Daniel Gross, however, it seems like TARP will at least break even.   

The spreadsheets at financialstability.gov document the status of the 667 investments, worth $204.4 billion, made under the CPP. Morgan Stanley, which borrowed $10 billion in October 2008, paid back the cash in June and purchased the warrants for $950 million on Aug. 12, giving taxpayers a 12.7 percent return, according to SNL Financial. For the 22 companies that have bought back shares and warrants, the taxpayer received an annualized return of 17.5 percent—better than most hedge funds have done lately. (Another 15 have repaid part or all of the principal.) Since many of the largest financial institutions have left the program, the 37 "exits" represent 34 percent of the total cash initially disbursed. The bottom line: taxpayers have received $70.3 billion in principal, plus about $10 billion in dividends and warrant payments....

Investors have seen other returns. Since the Treasury Department in July converted the $25 billion CPP loan to Citi into common stock, at $3.25 a share, the U.S. taxpayer now holds 7.69 billion shares of the once mighty bank. As of Aug. 26, thanks to the rallying market, taxpayers were sitting on a $10.52 billion paper gain....

Given the results of the central-bank bailout thus far, Herb Allison, the former TIAA-CREF CEO who was tapped to run TARP, notes that "it's quite possible we'll have a positive return on the CPP program as a whole."

Regardless, the CPP —combined with all the other stabilization efforts—has become less of a political and financial liability than it was last fall. In late August, the Office of Management and Budget said the lower-than-expected cost of bailing out the financial system—including the money paid back from the CPP—meant the 2009 fiscal deficit would be $1.58 trillion, $262 billion less than the prior estimate of $1.84 trillion. Lee Sachs, counselor to the Treasury secretary, invokes the MasterCard ad in weighing the true yield. "Dividends: 5 percent; equity warrants: 2 percent. Financial system not going into total abyss: priceless."

In essence, the U.S. Federal Reserve has acted like the Mother of All Sovereign Wealth Funds for the past two years.  It placed a huge bet that most financial assets were being radically undervalued during the Great Panic last fall.  That bet appears to have paid off handsomely.  Oh, and the complete and utter collapse of the financial system was averted. 

Ben Bernanke has some significant political skills, and one would expect him to be able to put the best possible spin on this kind of news. 

Still, I wonder if it will do him any good.  When you have a 30% approval rating, it's pretty easy for the other 70% to concoct stories that take good news and turn it into a narrative of evil. 

In this case, I can easily imagine Bernanke's opponents combining this news with rumors about the Plunge Protection Team, nostalgia for the gold standard, a jeremiad by William Greider, and the belief that if the Fed made a profit that means it must have screwed the old, the poor and minorities out of their hard-earned money.  Mix together well, and I think you have a story that would make Fed-haters feel quite comfortable in their convictions.

Readers are encouraged to proffer their narrative for why Ben Bernanke is evil despite apparent policy successes in the comments.  The more outlandish, the better -- I want to be ahead of Glenn Beck and Keith Olbermann on this one. 

The IMF announced "preliminary agreement" on a voluntary code of conduct for sovereign wealth funds yesterday.  The indispensible SWF Radar has a roundup of links.  For me, Krishna Guha's story in the Financial Times provides the most revealing detail: 

The International Working Group of Sovereign Wealth Funds had to bridge significant differences between funds with different histories, domestic political environments and mandates. People familiar with the discussions say some funds are more sophisticated and politically savvy than others, with differences surfacing between more established funds and relative newcomers. Some funds were also more resistant to financial transparency than others, a divide that did not necessarily tally with how long the funds had been in operation. Some saw value in formalising transparency regimes in order to reassure their domestic audiences that the money was being wisely invested and accounted for. Others wanted to retain a greater degree of secrecy.

This cleavage among SWFs doesn't surprise me -- what surprises me is that it took so long for this schism to be reported in the press.  My impression had always been that older, more established funds -- the ones based in Abu Dhabi, Singapore, Kuwait, etc. -- were pretty steamed that nouveau riche funds from China and Russia were bringing so much negative press attention onto them.  It doesn't surprise me that the older funds were willing to commit to standards that would placate recipient countries.  [So, does this agreement mean anything?--ed.  Since the actual Generally Accepted Principles and Practices (GAPP) for Sovereign Wealth Funds won't be released until October at the earliest, it's hard to say.  One would think a voluntary code of conduct would not matter so much, but compliance with principles on transparency and governance are pretty easy to observe and monitor.  This, combined with the fact that the biggest recipient countries and the largest SWFs have a big incentive for the GAPP to work, leads me to think that this will mean something.] 

Love them or hate them, sovereign wealth funds helped to bail out a lot of U.S. financial institutions over the past 18 months.  According to McKinsey, these funds invested $59 billion into Western financial institutions from March 2007 to June 2008.  Since Freddia Mac and Fannie Mae hit the fan, however, sovereign wealth funds have stayed on the sidelines.  Indeed, when the Kuwait Investment Authority announced that it wasn't ploughing more money into the United States and was instead focusing on China and India, a lot of people freaked.  Am I one of the people freaking out?  No, because I'm not convinced that sovereign wealth funds are all that good at picking winners in equity markets.  Which leads me to this SSRN paper, "The Financial Impact of Sovereign Wealth Fund Investments in Listed Companies," by Veljko Fotak, Bernardo Bortolotti, and William L. Megginson.  Here's the abstract:

This paper initiates empirical research on the financial impact and wealth effects of Sovereign Wealth Fund (SWF) investments in the stock of listed companies around the world. SWFs have recently gained media attention because of concerns about their large size (USD 3.3 trillion), extremely rapid growth rates, and lack of transparency. We analyze asset allocation by fund and find a significantly positive 1% mean abnormal return upon announcement of 75 SWF acquisitions of equity stakes in publicly traded companies around the world. We note that SWFs are typically long term investors who, due to both political pressures and size of holdings, are often unwilling to quickly unwind their positions. However, two-year abnormal returns of SWFs average a significantly negative 41%, suggesting equity acquisitions by SWFs are followed by deteriorating firm performance. 

I'm not sure how robust their findings are -- the N is under 60, and there are selection effects all over the place -- but if their finding holds up, it suggests that sovereign wealth funds are hardly the master of the markets that some people believe them to be.  It also suggests, perversely, that their decision not to send more money into the U.S. might be a good thing in the long run.