The Bailout: What Does Paulson Do Now?

With the House of Representatives' Oct. 3 passage of the Treasury's $700 billion plan to stabilize the financial markets by buying up troubled mortgage-related assets, you could almost hear the sigh of relief spreading throughout Washington and Wall Street. After two weeks of nearly nonstop negotiations in which the bill repeatedly appeared to flounder, it was quickly passed on to President George W. Bush, who signed it into law within hours.

Now comes the hard part: getting the Mother of All Buyout Funds up and running.

Treasury officials have made clear they want to do that as soon as possible, and have told congressional leaders and Wall Street executives that they will conduct the first auction to buy assets within four weeks. The work needed to accomplish that is well under way, by a team of Treasury officials led by Ed Forst, a Goldman Sachs (GS) alumnus who left the firm this summer to become a senior administrator at Harvard University. In late September, Paulson asked him to come to Treasury to work on the bailout program. Forst, who is on a temporary contract, began to outline the plans for implementation even as Congress wrangled over the details. With the deal now done, Treasury hopes to hire five to 10 asset managers to oversee the purchases, each of whom will manage up to $50 billion in assets. It also hopes to hire another couple of dozen bankers, lawyers, and accountants needed to run the program, with much of the hiring expected within the month.

"Treasury is acutely aware that it must build an early record of success in order to maintain market and political confidence," says Howard Glaser, a high-ranking housing official in the Clinton Administration and former chief lobbyist for the Mortgage Bankers Association who now runs the Glaser Group consulting firm. "Paulson did not want to lose precious days waiting for Congress to pass the final bill before putting together the implementation plan."

Purchasing Discretion

Already, Paulson's priorities are becoming clear. It will have to decide which assets to go after first, and who to buy them from. Congress has given Treasury wide discretion to decide what assets to target. Although most of the funding is likely to go toward buying up mortgage-backed securities and whole home loans still held on the books of the lenders who originated them, Treasury can also buy up construction loans, home equity loans, or even credit-card debt or car loans if it decides that is necessary.

Treasury also has plenty of room to determine which types of institutions to buy from. Though banks, investment banks, and insurers are high on the list, the purchases could also be extended to hedge funds and others if need be.

Sources closely following the plans say that Paulson is intently focused on making sure Treasury gets the biggest bang for its billions. "It can't do anything too exotic right off the bat," says Tom Gallagher, the head of Washington policy research for institutional broker ISI Group. "It needs to have a quick impact."

So the first order of business will be ensuring that the initial auctions it holds to buy up assets are a big success—indeed, some say Treasury wants to see that they are oversubscribed. Those will be "reverse" auctions, in which sellers compete by submitting prices they would be willing to accept, generally allowing the buyer to select the lowest. So rather than Treasury bidding a certain amount to buy up a bundle of mortgage-backed securities, for example, the agency would tell financial institutions that it wanted to buy up a particular type of mortgage-related debt. Then it would buy those securities from whichever seller offered them for the lowest price.

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