Sunday, October 5, 2008

Channeling Paulson: The bailout will soon be a reality. Only Henry Paulson knows what happens next.

It's been 14 days since Henry Paulson injected the mega-bailout into all of our lives. Fourteen days since he lumbered on stage at the Treasury Department to propose a rescue plan of hundreds of billions of dollars. Fourteen days since the presidential race was thrown upside down. Fourteen days since the country started explicitly living under a threat of a total credit drought. Fourteen days since the country saw its elected leaders promise salvation, fail to deliver, and promise it all over again.

And yet, 14 days later, we still don't know much about how the bailout is actually going to work.
The man in control of it all is Henry Paulson-the former CEO of Goldman Sachs and the new symbol of American capitalism. Despite two weeks of back-and-forth on the bill, Paulson is nearly as short on bailout details as he was when we began this process. Part of this is necessity-he didn't know the kind of leeway Congress was going to give him to work with-and part of it is prudent policy-this whole plan has been so rushed that there's no reason to commit to a tactic when an entirely new strategy could emerge. There's a nagging thought, though, that Paulson himself doesn't yet know what he's going to do.

The bill itself doesn't provide any help. It demands Paulson explain how this whole thing is going to work two days after the first troubled assets are purchased. At that point, Paulson must outline the following details:

1) Mechanisms for purchasing troubled assets
2) Methods for pricing and valuing troubled assets
3) Procedures for selecting asset managers
4) Criteria for identifying troubled assets for purchase
(The above order is the one Congress proposed in the legislation. Let's hope Paulson thinks in a more logical sequence. We'd recommend starting with No. 4 and working his way up.)


For now, all of this leaves us, the American public, scraping for some answers. Referring to that elementary series of questions we learned in grade school-who, what, where, when, why, and how-the only one that's been explicitly answered is why. We know that Paulson thinks we're all destined for Hooverville if we don't vacuum troubled assets from bank sheets. When the House shot down the bailout last week, Paulson's mantra sounded like it was stolen from Heroes. Save the bailout, save the world.

So, 14 days since Paulson originally proposed the plan, it's worth trying to answer the other five questions.

When is all of this going to happen?
Nobody knows for sure. The bill does not impose a timeline on Paulson, but he's been very adamant about the fierce urgency of now. Still, it will probably be at least a few weeks, based on a call between the Treasury Department and bankers last Sunday (before the first bill failed). The stunning, paraphrased transcript, courtesy of Dealbreaker:

Q: Mike Holt, Boston Co.: When will the Treasury start purchasing these assets? Wednesday? A couple weeks?A: A few weeks, several weeks, once Congress passes bill.Q: But some people will fail before that?A: We understand. So, expect some Darwinian havoc for a few weeks even after the bailout bill passes. Without fully forged tools, the Treasury Deptartment will be handcuffed and unable to save failing banks. Reminder: According to Paulson, the bailout is necessary because without it, banks will fail.

Who is going to run this thing?
Nobody knows for sure. The bill says that the Treasury can contract out for portfolio managers to manage the superfund. Paulson can also bring in the expertise of the FDIC, according to the bill, but it doesn't seem to make much sense given the FDIC manages banks, not hedge funds-which is what the bailout pool would be. In a conversation with the Treasury Department, The Big Money was led to believe that it would be a job for somebody from the private sector. Knowing Paulson and his ties to Wall Street, we imagine that he'll bring in a bold-faced name to assuage the markets and inspire confidence. Whoever comes in will still report to Paulson but will presumably operate the superfund day to day in something called the "Office of Financial Stability." Anti-anxiety medication will be handed out at the door.

What kind of assets are we going to buy?
Nobody knows for sure. The bill mandates a purchase of "troubled assets from any financial institution." Interpreted loosely, that could mean tax dollars could be spent purchasing a depressed, yet invaluable, bank employee. The bill does emphasize mortgages and mortgage-backed securities in several places, so expect those to be the first to be purchased, according to TBM's talks with the Treasury Department. But expect whole mortgages to be gobbled up, probably by the government's new Rottweilers, Fannie Mae and Freddie Mac. We've already seen the government help out with troubled credit-default swaps when they bailed out AIG, so that's a possibility, as well. The opportunities are endless!

How much are we going to pay for these assets?
Nobody knows for sure. The bill gives Paulson total control in the matter as long as he writes a memo or two on the subject. Two main options: The government pays market value (not very much) or original value (way too much). If we go with the first avenue, we'll probably use a reverse auction, which would allow the government to buy toxic assets at the lowest price and establish a price floor for the assets in the broader marketplace. Warren Buffett is a staunch ally of this option. That route, though, may not inject enough capital-read: new cash-into the financial sector. Without new capital, we're told banks still won't feel comfortable lending out new credit. If the government is convinced the banks need more money, then they're more likely to purchase the assets straight off and more likely to pay higher prices in the range of what the assets were once worth. Ben Bernanke and Paulson refused to shoot down this option during testimony last week and seemed to favor it at some points. (During other moments, they seemed to favor reverse auctions.) Some econopundits are furious about the potential harm to taxpayers, but it may be a necessary move if initial market-rate purchases don't grease the wheels.

Where will all of the bailed-out banks be headquartered-in the United States?
Nobody knows for sure. The bill says any bank headquartered anywhere in the world is eligible for the bailout even if they don't do business in the United States. The, uh, money quote from the legislation:

To the extent that such foreign financial authorities or banks hold troubled assets as a result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets qualify for purchase under section 101.

We don't know whether Paulson will act upon that possibility. At first, he suggested he didn't want foreign banks included, then backtracked once he realized that whole globalization thing applied. Paulson's actions, most likely, will depend on what other governments and central banks do around the world. The European Union rejected a plan to create a rescue fund for their banks. If nobody else purchases toxic assets abroad, the United States may be forced to fill the international void.

After all the wrangling, though, we do know one thing for sure. There will be a bailout. Fourteen days from now, maybe we'll find out what that means.

By Chadwick Matlin Posted Friday, October 3, 2008 - 1:32pm [he_big_money171:http://tbm.thebigmoney.com/articles/making-bail/2008/10/03/channeling-paulson]

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