Bailout bill passes: what now?

Now that the bailout bill has passed, just how will the government figure out how to spend those hundreds of billions of dollars? How will they value the securities they're going to buy? Is there a plan? A story in the L.A. Times ponders the question:

The measure gives the Treasury Department up to 45 days to set up the acquisition system, and so far Treasury Secretary Henry M. Paulson has said little about how he planned to implement his new authority. In a statement Friday, Paulson said Treasury would move rapidly but "methodically" to use its "broad set of tools."

Securities experts say the system needs to minimize the possibility that certain firms would be favored at the expense of others -- especially given Paulson's ties to Wall Street as the former chairman of Goldman Sachs Group Inc...

So far, the most detailed indications of Paulson's intentions came in his testimony last month before the Senate Banking Committee.

At that time, he said Treasury would hire five to 10 outside asset managers, presumably from Wall Street, and suggested that one possible approach would entail financial institutions bidding against one another to offer their troubled assets to the government. In one scenario, known as a reverse auction, the companies would reduce their bid prices until they hit a mark the government would accept.

The agency would do "a certain amount of experimentation," Paulson said...

Still unknown is how Treasury might compensate its outside asset managers. One investment firm, Newport Beach-based Pacific Investment Management Co., known as Pimco, offered to conduct the auctions for free -- if its competitors agreed to do the same. Treasury has not publicly responded...

Economists, bond traders and securities brokers say the process is certain to be vastly more complicated than a simple auction. The reason is that the assets to be purchased are a far cry from the objects customarily sold on EBay or, for that matter, the complex financial instruments traded on futures exchanges...

On the selling block will be at least 100,000 individual mortgage-backed bonds and other troubled securities along with a larger number of individual mortgage loans, according to a recent report by New York-based NERA Economic Consulting.

Before making their purchases, trading experts say, Treasury officials or their agents will have to develop a working model of the exotic mortgage securities' true value -- what they're worth given their probable cash flow to maturity...

The so-called mortgage-backed securities that have pushed some of the nation's biggest financial institutions to collapse consists of home loans that were bundled together and sold to investors. Each security is a unique package of loans from different parts of the country, with different borrower characteristics. The potential for unpleasant surprises is ever-present...

Some provisions Congress added to Paulson's original bailout plan, many of which were ostensibly designed to protect taxpayers' interests, will further complicate the process. The final bill allows government officials to take equity stakes in institutions that sell their troubled assets to the Treasury and impose limitations on executive compensation. Both represent costs that the selling institutions will tend to consider in setting their sale prices on the assets.

Then there's the oversight mechanism Congress imposed. Among other things, it requires Treasury to make the details of every transaction public. That's an admirable effort to create transparency for the bailout program, but it won't make the buying and selling of the securities any easier...

One important consideration will be guarding against conflicts of interest among the government-appointed money managers.

On the face of it, that will be a challenge because bond-trading firms participate in the market for themselves and clients and often manage their own portfolios of mortgage-backed securities. The value of those holdings will be influenced by the prices set through the government program.

The management firms considered likely to seek a role include Pimco, New York-based BlackRock Inc., and Pasadena-based Western Asset Management, all of which manage fixed-income portfolios worth hundreds of billions, including holdings in mortgage-backed securities.