Correction to This Article
This analysis article incorrectly said that the financial rescue package being considered by Congress would give the government the power to limit to $500,000 the annual compensation of executives of financial services companies participating in the program. The bill sets a $500,000 limit on the tax deductibility of the pay packages of those executives.

Dr. Paulson's Tough Medicine, In a Pill the Public Can Swallow

At its core, the proposed law contains three key elements -- the auctions, the negotiated recapitalizations and the foreclosure mitigation -- sought by Treasury Secretary Henry Paulson.
At its core, the proposed law contains three key elements -- the auctions, the negotiated recapitalizations and the foreclosure mitigation -- sought by Treasury Secretary Henry Paulson. (By Richard A. Lipski -- The Washington Post)
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By Steven Pearlstein
Washington Post Staff Writer
Monday, September 29, 2008

After a week of political brinksmanship and 100 pages of concessions to political reality, Treasury Secretary Hank Paulson seems to have finally won the power and money he asked for to mount an unprecedented rescue of the financial system.

If approved by a reluctant Congress and signed into law by the president, the Economic Stabilization Act of 2008 will authorize Paulson to continue in a bigger and systematic way what the Treasury and Federal Reserve have been doing since March when they committed $29 billion to facilitate the sale of Bear Stearns to its stronger rival, J.P. Morgan Chase. And although the initial focus will be on home mortgages and mortgage-backed securities, there remains enough flexibility in the legislation for Paulson to address similar problems with auto loans, credit card debt and loans for commercial real estate.

Global investors no doubt will cheer the weekend's political breakthrough, focusing less on the details than on the perceived commitment by the United States to do whatever is necessary to prevent a meltdown in global financial markets.

But nobody should view even this effort as sufficient to keep the U.S. economy out of recession, stabilize housing markets or prevent the failure of additional banks, investment houses, insurers and hedge funds. Although more than $600 billion in private-sector credit losses have already been posted, a number of private and public-sector analysts now estimate that won't be even half the final tab from the bursting of the greatest credit bubble the world has seen.

The normally sure-footed Paulson stumbled badly last weekend when he rushed to the Capitol with a vague and poorly explained proposal that all but invited politicians and the news media to label it as a "$700 billion bailout for Wall Street" -- a moniker from which it nearly never recovered.

In fact, even in its original form, the Paulson plan would not have cost taxpayers anywhere near $700 billion, nor was Wall Street ever to be the primary beneficiary. The aim all along was to restore the flow of credit to Main Street's homeowners and businesses through banking and credit channels that have become dangerously constricted in recent months, threatening to choke off capital to the entire economy.

By acting as a buyer of last resort and allowing financial institutions to compete to sell some of their depressed mortgage-backed securities, Paulson hoped to jump-start credit markets to the point that prices for the securities would rise to close to their real economic value, private investors would feel confident enough to re-enter the market and banks would have the capital to begin lending again.

Paulson also intended to use some of the money to inject fresh capital into banks and financial institutions whose failure would jeopardize the stability of the financial system, in exchange for government ownership and control, much as the Treasury and Fed had done with Fannie Mae, Freddie Mac and insurance giant AIG.

And all along he had made informal promises to congressional leaders that, as the government gained effective control of millions of troubled mortgages, it would use its newfound position to prevent unnecessary foreclosures by renegotiating the loans on more favorable terms.

All three elements -- the auctions, the negotiated recapitalizations and the foreclosure mitigation -- survived the week's negotiations and remain the core of the 106-page bill, along with the mandate to implement the program quickly, to structure it as he sees fit and to alter it as market conditions require.

What was added over the past week was a panoply of procedural safeguards, taxpayer protection and structural reforms to provide an acceptable political context for the use of so much public money and the grant of such extraordinary discretion and power.

Although the Treasury secretary will have a free hand in hiring staff and outside contractors, buying assets and negotiating the terms of government investment in struggling banks, he will have to answer to a board consisting of five other top government officials, be required to post the details of everything he does on the Internet and be subject to constant oversight by two congressional committees, a battalion of government auditors and a special inspector general.

For the first time, the federal government will limit the compensation of some top corporate executives to $500,000 annually -- directly in the case of big banks that participate heavily in the new program and through limits on tax deductions for everyone else. There will be tough restrictions on golden parachutes and clawback provisions for bonuses based on profits that later disappear.

And the legislation takes not-too-subtle swipes at nearly all federal regulators of the financial system, directing the Securities and Exchange Commission to review the wisdom of "mark-to-market" accounting, chiding the Treasury for unilaterally extending deposit insurance to money-market funds and requiring the Fed to make a monthly accounting for its bailouts of Bear Stearns and AIG. A five-member blue ribbon panel of outside experts is to recommend a new regulatory blueprint for the financial services industry -- including supervision of hedge funds and derivative trading -- by Inauguration Day in January.

Finally, the legislation contains several mechanisms for the government to recoup all of its money, and perhaps even turn a profit, by collecting insurance premiums, demanding stock from participating banks and, should all else fail, slapping a new tax on the financial services industry beginning in 2014.

Normally, the mere discussion of such measures would have brought on a furious lobbying effort to kill them. But it is a measure of the industry's newfound impotence in Washington that it was forced to sit silently on the sidelines over the weekend as Republicans and Democrats, leaders and backbenchers joined hands in demanding that Wall Street foot the bill for the mess it has created.

Steven Pearlstein can be reached

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