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Paulson Moves On to Nuts and Bolts of Rescue
Secretary Begins With Search to Tap Expertise of Leading Wall Street Firms

By David Cho
Washington Post Staff Writer
Saturday, October 4, 2008

With the political battle over the Bush administration's $700 billion financial rescue package at an end and the real work of rescuing the financial markets just beginning, all eyes are turning to Treasury Secretary Henry M. Paulson Jr.

The bill gave him unprecedented powers to shore up the ailing financial system. With few constraints, Paulson will make all the key decisions on who to hire, when to launch the program and perhaps most importantly how much the government will pay for troubled assets from ailing Wall Street firms. A misstep could mean hundreds of billions in losses for taxpayers or a cascade of failures for banks.

Speculation was rampant on Wall Street yesterday about who Treasury would hire to manage the assets that the government plans to buy. Industry sources say the department has asked leading Wall Street firms for feedback and that Legg Mason, Pimco, BlackRock and MKP Capital Management were recommended to Treasury.

These firms rose to the top of the list because of their expertise in mortgage-related assets. But hiring them as asset managers for the government would raise the potential for conflicts of interest, particularly because they would be managing the assets while also selling their own troubled securities to the government.

Treasury spokeswoman Michele Davis said the department plans to develop and publish guidance on "how to manage any conflicts." It is planning to put out a formal request for services Monday.

Besides hiring five to 10 asset managers, Paulson is seeking a top executive to oversee the program with the rank of assistant secretary of the Treasury as well as about two dozen bankers, lawyers and accountants.

Paulson urged Congress to pass the bailout plan quickly because credit markets were freezing up. Banks and investors were reluctant to make even overnight loans for fear that they would not get their money repaid. But the passage of the plan yesterday did not immediately ease the credit crunch.

Mohamed A. el-Erian, co-chief executive of the giant asset management firm Pimco, said that short-term credit trading for anyone other than the federal government remained at a "virtually nonexistent level."

"While constituting a necessary condition," he said, "the rescue package is not sufficient to radically counter the immediate disruptions."

Investors continued to pour money into Treasury bills, the banking equivalent closest to sticking money in a mattress, driving down the yield on short-term Treasuries to close to zero.

Paulson never claimed the bailout package would solve all of Wall Street's woes or prevent the economy from falling into a deep recession. Treasury officials even warned banking groups this week that firms may collapse before the program launches, which likely will take place in mid-November.

Well aware of the pressures on him, Paulson feels "the weight of the world on his shoulders," according to source close to him who talked to him recently and spoke on condition of anonymity because the conversation was private.

Yesterday, Paulson said the expanded powers will give Treasury the flexibility to address the worsening credit crisis.

"There is no one-size-fits-all solution to alleviating the stress in our financial system," he said in a statement after President Bush signed the bill into law. "The broad authorities in this legislation, when combined with existing regulatory authorities and resources, gives us the ability to protect and recapitalize our financial system as we work through the stresses in our credit markets."

The bill gives Paulson a wide range of options to buy the troubled assets. In some cases, the Treasury plans to use auctions to obtain a low price. In other cases, the government can lend directly to firms, but it would likely require them to relinquish control over their executive pay and hand over a major equity stake to the Treasury. Similar conditions applied to the $85 billion government loan that rescued insurance giant American International Group last month.

Despite his expansive powers, Paulson faces a morass of legal and financial issues in setting up the program.

Treasury officials expect every decision -- including which firms these new hires come from, how much they will be paid by the government and potential conflicts of interest -- to be scrutinized by Congress and the news media.

The Treasury faces a delicate balancing act to properly price the assets it will buy. Treasury officials plan to begin buying simple mortgage assets to gain experience running the program. But under the bill, they can expand the scope of their purchases to any financial firm that has a meaningful presence in the United States and to any assets that are being held by these companies.

The trick, Paulson said in an interview earlier this week, is coming up with the right price. If the government overpays, taxpayers could be saddled with hundreds of billions of dollars in losses. Paying too little could force other banks to write down assets that are similar in nature, which in turn could trigger a cascade of bank failures.

"Whatever methodology they use, I'm sure they are going to be trying all kinds of things, so it will be a little bit of a learning experience," said Timothy Ryan, chief executive of Securities Industry and Financial Markets Association. "A lot of what they will be doing is answering . . . questions, and the biggest one is the transparency around pricing."

Treasury officials said they plan to make the process of finding the right price transparent to help the market accurately value all of its assets, even the ones that the government does not buy.

Treasury got a head start on the work. Last month, Paulson tapped Ed Forst, a Harvard University executive who formerly worked for Paulson when they were at Goldman Sachs, to work on setting up the plan, even while Congress was still debating the bill.

"Paulson did not want to lose precious days waiting for Congress to pass the final bill before putting together the implementation plan," said Howard Glaser, president of the mortgage consulting firm Glaser Group.

Glaser also predicts Treasury will focus on helping community banks, Glaser said.

"Supporting the smaller regional banks and thrifts provide critical political support for Treasury's efforts . . . and they are very stabilizing in their communities," he said. "Congressmen who had to swallow hard to vote for this thing will feel a lot better about it if they see the impact in their local communities."

While it is imperative for Treasury to get the program running as soon as possible to prevent more collapses in the financial system, Ryan said, "doing the program right is more important than doing it quickly."

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