Putting The Bailout On Hold

So far, Congress has not shown any inclination to buy into the Paulson-Bernanke proposal to give the Treasury a clean piece of legislation so that it can purchase up to $700 billion in toxic assets held by banks.

In testimony he will give to the Senate Banking Committee, Bernanke will say that "Action by Congress is urgently required to stabilize the situation and avert what could otherwise be very serious consequences for our financial markets and our economy."

While everyone from the banking industry to the House and Senate says that they agree, that is clearly not the case. Congress would like riders on the bill for executive compensation, mortgage relief, and provisions may be added for foreign banks and credit card loans.

Getting a simple program in place is becoming less and less likely.

What has emerged is that the Treasury is highly likely to use an auction system to purchase mortgage-related paper from banks. That will prevent aribitrary pricing which could expose the government to charges that it paid too much for the mistakes of bank managements. The bailout would become a gift, isolating financial companies from having to take new write-downs for the real value of the junk on their balance sheets.

One of the questions which is rarely asked is why the Fed does not call the bluff of Congress and say that the free market will be left to do the bidding. The action would have the power of either getting the legislature on board or throwing the entire problem into the lap of the private sector.

As Congress fights over who will be saved by the bill and who will not be. the size and scope of the global capital markets have been ignored.

The conventional wisdom is that the global financial system could not afford to buy up $700 billion in distressed paper. That may not be true. The size of soverign funds in Asia and the Middle East combined with the value of large private equity funds stretches into the trillions of dollars.

Abu Dhabi Investment Authority controls as much as $1 trillion. One fund among others which may be just as large.

The bank assets which are for sale will go at some fraction of their original value. If that number is to be set in an auction, the Treasury says it can make a fortune as the value of the assets appreciates in an improving economic and housing market. Because of this taxpayers may end up footing little if any of the costs of the bailout.

Sovereign funds and private capital determine what they will pay for their investments in a similar way. To keep from over-spending they make sure, to the extent that they can, that there are several bidders for any debt, equity, real estate, or company that they buy.

A global auction systems is already in place. It can put a fair, and probably very low value on US bank assets. The Treasury will do no different.

If the fighting in Washington goes on, the free market may handle the bailout by default. The beauty of that is it will probably work.

Douglas A. McIntyre