Wall Street Bailout Faces Lawmakers, Lobbyists

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And with the Treasury potentially committing hundreds of billions of dollars to buy dubious financial assets from shaky financial institutions over the course of two years, another critical question remains unresolved: at what price? The Treasury has said it would try to pay "market prices," perhaps using reverse auctions, but the market for the securities has all but seized up in recent weeks. Merrill Lynch (MER) sold a chunk of mortgage-backed securities for about 22¢ on the dollar earlier this summer. Other firms value their securities much higher than that, leaving a central question: What is a good guideline for Treasury acquisitions?

Pay too much, and the rescue plan begins to smack of a bailout—or even a windfall for what remains of Wall Street. Indeed, the less the government pays, the better its odds of breaking even on the bailout or even turning a profit when it is eventually able to sell off the assets. But pay too little, and the fix could prove not much better than the crisis—which, after all, stems in large part from writedowns of these very assets —minimizing any benefit from the government stepping in at all. The risk is that the government becomes a "dumping ground," says Lawrence White, a New York University economist. "Do we want to have a government entity buying difficult-to-value assets at God knows what price?"

No Relief for Hedge Funds

Then come the related questions: What will the government actually buy, and from whom? The proposal's vague language gives Treasury broad leeway to buy up "mortgage-related assets"—but the Treasury made clear that, after consulting with the Federal Reserve, it could buy assets beyond whole and securitized loans, potentially including derivatives based on the value of those mortgages. Some observers speculate it could even mean wading into the enormous market for credit default swaps, those contracts that rise and fall on the creditworthiness of a range of financial and nonfinancial companies.

As for where the government makes its purchases, the Treasury's proposal initially seemed to limit the relief to commercial and investment banks. It's less clear whether insurers would qualify. Hedge funds need not apply. Yet, as AIG's collapse and bailout show, large insurers have become inextricably entwined in many aspects of the U.S. financial system. And investment banks' proprietary trading desks have swollen in recent years, allowing them to make sometimes giant bets in the market using the firms' own money, much as an in-house hedge fund would. As the weekend closed, financial-services lobbyists were poised to make the case that the final measure should cover not just banks and insurers, but mortgage originators and bank affiliates as well, and allow the Treasury to buy commercial loans tied to housing and real-estate construction in addition to residential and commercial mortgages.

Then there's the question of accountability: What should the government demand in return from the companies it bails out? As the Treasury's proposal stands now, financial firms are spared sacrifices. The plan proposed no tighter limits on the leverage they can carry, no changes to corporate governance, no requirement that they better disclose the risks they face or the assets underpinning their balance sheets. Also unresolved: whether the executives who piled on the debt and raked in the shaky securities should have to return any of what they made along the way. Frank, the Massachusetts Democrat, is leading the charge in Congress to add compensation limits to rein in the pay of executives whose companies benefit from the bailout. Although the Presidential candidates have both lambasted executive greed with increasing vigor in recent days, banking lobbyists are sure to oppose any such move. And Paulson warned that such reforms should come after the markets have stabilized.

Candidates Demand Accountability

On the campaign trail, the candidates hewed closely to their earlier positions: measured support for the Treasury's proposal, demands for accountability, and reassurances that they were looking out for average Americans.

At an appearance in Charlotte, N.C., on Sunday, Obama criticized the Administration for offering only "a concept with a staggering price tag, not a plan." He said the final proposal should include provisions ensuring that companies aided by it also share in its cost, help struggling homeowners remain in their homes, and coordinate with other countries. He also called for an economic stimulus package. "We must work quickly in a bipartisan fashion to resolve this crisis to avert an even broader economic catastrophe," he said in remarks prepared for the appearance. "But Washington also has to recognize that economic recovery requires that we act not just to address the crisis on Wall Street, but also the crisis on Main Street and around kitchen tables across America."

Republican Presidential candidate John McCain, too, has called for an end to corporate bailouts. On Sept. 19, he said he would reserve judgment of the Treasury's plan until its details became known, but reiterated his own proposal for a new division of the Treasury to buy up questionable mortgage-related assets. His proposed "Mortgage & Financial Institutions Trust," would help companies identify bad loans, lend money at reasonable rates, "provide funding and eventually sell them at a profit." In return, the agency would receive warrants for "controlling interest in troubled institutions." Financial companies under the proposal would "keep operating as private companies" with the new agency's help.

Francis is a correspondent in BusinessWeek's Washington bureau

Sasseen is BusinessWeek's Washington bureau chief

Francis is a writer in BusinessWeek's Washington bureau. Sasseen is Washington bureau chief for BusinessWeek.