Paulson Plan dubbed “a necessary evil”

WASHINGTON, DC – Senators on the Senate Banking Committee have aired their concerns in a hearing to discuss the proposed adoption of the so-called Paulson Plan – the $700 billion bailout of the financial services industry by buying up troubled illiquid assets in the market.

Treasury secretary Henry Paulson, Federal Reserve chairman Ben Bernanke, US Securities and Exchange chairman Christopher Cox and director of the Federal Housing Finance Agency James Lockhart each gave prepared statements in support of the Troubled Asset Relief Program (TARP) Bill and answered questions posed by committee members.

Concerns centred on the lack of any oversight for Treasury in the proposed legislation, the degree of flexibility the department would have buying the troubled assets, and concern about whether taxpayers would receive a return, if any, on their investment. Committee members also found it difficult to look past the bill as a bailout for excessively compensated banking individuals who managed risk poorly. Before handing over a ‘blank cheque’ and ‘rubber stamping’ this plan, the committee sought to gain answers to these concerns.

Paulson said there was no provision for regulatory oversight regarding Treasury in the plan because he agreed in a meeting with the committee chairman Christopher Dodd during emergency discussions held on Thursday night (September 18) that it would come up with “something they could work with Congress with”. To this end, Paulson stated he had presented a three-page legislative outline and that it would have been presumptuous for him to include oversight requirements for the mechanism, which he said was for Congress to do. “We want oversight,” he said, “We welcome it but in a way that lets the programme work effectively and quickly to get the job done.”

How the assets would be priced was also a major question posed to the panel of regulators. Bernanke explained how the mechanism could work. Because there is no market for these complex illiquid mortgage-backed securities assets, the estimated fire-sale price is artificially low compared with the hold-to-maturity price. One option is to suspend mark-to-market rules – which the banks favour – but this would not help the damaged market as it is still not known what the hold-to-maturity price is. A more preferred option is the use of reverse-auctions designed to give the market an idea of what the hold-to-maturity-price could be, which would allow Treasury to buy the assets at close that price, ensuring return on the taxpayers’ investment. This mechanism would also allow the banking firms that hold these assets to value them more accurately and attract new capital.

The vague description of exactly how these auctions will work – which is why the Treasury has built a great degree of flexibility into the plan – is worrying committee members and might be a sticking point in the days to come. The hearing is still ongoing and the panel will be up before the House Committee on Financial Services tomorrow.