While Lawmakers Reach Credit Crisis Compromise, Money Morning Bailout Plan Expert Displays Doubt

By Jason Simpkins, Jennifer Yousfi
And William Patalon III
Money Morning Editors

Congressional negotiators late yesterday (Thursday) reached a tentative agreement on a credit-crisis compromise that gives the Bush administration about a third of the $700 billion it has requested up front, but made sure half that outlay was subject to a congressional veto, published reports state.

Details remained sketchy late yesterday. However, this much is known. Under the plan – known as the "Troubled Assets Rescue Plan," or TARP – U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. would get an immediate $250 billion to begin bailout operations, and could obtain an additional $100 billion if needed. The final installment of $350 billion could be blocked by a Congressional vote.

TARP is designed to give lawmakers a controlling stake in the unprecedented credit-crisis bailout plan, industry sources and The Associated Press both reported. Money Morning Contributing Editor R. Shah Gilani – a former hedge-fund manager and currency trader who this week proposed an alternate plan that wouldn't burden taxpayers with billions in federal debt – said it will be tough to evaluate TARP until all the details are known.

But he clearly didn't have strongly positive feelings about either Paulson's original plan or the revised TARP proposal put forth by congressional negotiators late yesterday.

"Commenting on what's under the TARP [proposal] is like asking if there's a Hell below us," Gilani said in an interview late yesterday. "We won't know until we get there."

Anatomy of a Deal

The tentative plan calls for the federal government to buy the "toxic," mortgage-backed assets of failing – or failed – financial institutions in a bid to keep the U.S. financial system from melting down. A meltdown would be the penultimate event that would sap investor confidence, setting in motion a series of irreversible events that would wipe out savings, cause a big spike in home foreclosures, and ultimately, cause a major surge in unemployment after thousands of small businesses fail and major companies resort to widespread layoffs.

The Bush administration has made concessions almost daily to demands from both the political right and left from its original three-page proposal, including agreeing to limit pay for executives of bailed-out financial institutions.

Debate has been fierce on such questions as whether to phase in the cost and whether to give taxpayers an equity stake in rescued companies. House Financial Services Committee Chairman Barney Frank, D-Mass., told The Associated Press thatboth would be included in the legislation.

While details of the plan were not immediately provided, the compromise is said to include provisions to curb executive compensation for participating companies, provide more oversight of the Treasury's actions, and supply the government with stock warrants that let the government share in profits generated by participating Wall Street firms.

"We came to some agreements on a lot of important issues," Frank told The Los Angeles Times. "We are on track to pass this."

Investors Show Their Approval

U.S. stocks soared yesterday on news that Congress had reached an agreement.

After soaring as much as 300 points, the Dow Jones Industrial Average Index pared gains in late afternoon trading. But all three major U.S. indices still had solid jumps for the day, as optimism that Congress would soon pass the bailout legislation buoyed U.S. markets.

The blue-chip Dow gained 196.89 points (1.82%), to close at 11,022.06. The tech-laden Nasdaq Composite Index shot up 30.89 points (1.43%) for the day to 2,186.57. And the broader Standard & Poor's 500 Index rose 23.40 points (1.97%), to reach 1,209.27.

All sectors were up with the energy sector's 2.64% gain and the financial sector's 2.32% increase some of the highest.

"Optimism lies in the hope that we're nearing the end of the credit crisis and that Paulson's plan will help settle things down and businesses can get back to functioning as normal," James Gaul, a Boston-based money manager at Boston Advisors LLC, which oversees $1.8 billion, told Bloomberg News.

Financials such as JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC) posted gains of 7% and 4%, respectively. Other stocks such as IBM Corp. (IBM), up 3% for the day, gained on hopes that the bailout plan would lead to economic recovery and reignite consumer demand. 

A Wait-And-See Saga For Commodities

Gold fell yesterday, as investors waited to see the full details of the amended bailout plan. Gold for December delivery fell $13, a decline of 1.5%, to end at $882 an ounce on the Comex division of the New York Mercantile Exchange, MarketWatch reported.

"Until the bailout proposal becomes law, investors will remain reluctant to take big positions in a number of commodity complexes," Edward Meir, a commodities analyst at futures brokerage MF Global Ltd. (MF), told MarketWatch.

But that position could quickly reverse once the proposed bailout becomes law – causing gold and other precious metals to soar in price.

The plan "will continue to undermine the value of the U.S. dollar and further support a flow of capital out of paper into hard assets, into gold and silver," said Peter Spina, president of Gold Seek LLC.

Oil got a boost on hopes that the bailout would jumpstart the U.S. economy and spur demand. Crude oil for November delivery rose $2.29, or 2.2%, to close at $108.02 a barrel on the New York Mercantile Exchange, according to MarketWatch data.

The bailout plan "is certainly driving the [oil] market higher" on hopes of a recovery in the U.S. economy, said Mark Waggoner, president of Excel Futures. "Once the initiative is passed, however, the market should revert lower to $98-$100 levels," or even less.

Bush Backs Paulson's Plan

President Bush addressed the nation Wednesday night and tried to explain the crippling credit crisis, and why the costly bailout plan was needed, to the American public. 

"We're in the midst of a serious financial crisis," Bush said in a nationally televised address, MarketWatch reported. "Our entire economy is in danger," as a result of the credit crunch, he said, and inaction on the plan could result in a "long and painful recession."

The high price tag for the $700 proposed bailout has triggered fear and disbelief with many voters. But Bush did his best to reassure the nation that taxpayer funds are in good hands at the Treasury Department.

"We expect that much, if not all, of the tax dollars we invest will be paid back," Bush said.

Bush explained that the U.S. government was the only entity with the patience to hold the troubled securities until the credit markets unfreeze and return to a more normal state of operation.

Gilani, the Money Morning editor, said he's stunned over how quickly this so-called agreement was reached.

"It's mind-boggling to me to even attempt a compromise in only a matter of days with regard to $700 billion, as if that's tip money," he said. "There's something drafty in this whole process of hasty compromise and I'm afraid that it's going to turn into an ill wind and the worst kind of open partisan warfare after the fact."

Rather than receiving the entire $700 billion in one lump sum, the Treasury Department will receive $250 billion immediately, with the remainder to be paid in installments. This is intended to provide more congressional oversight.

"The question is, first … do they actually need the whole $700 billion?" asked Sen. Charles Schumer, D-NY. "And, second, what kind of checkpoints are there along the road?"

A protracted dispersion of funds should give Congress opportunities to monitor the bailout's effectiveness over the next several months, proponents of the new TARP proposal said.

But Gilani sees this "bailout installment plan" as being problematic.

"Doling out capital in installments to satisfy the market's ravenous appetite for liquidity is like giving a starving person a nickel to buy a meal," he said.

The new plan also includes caps on executive pay for company executives, which Paulson initially opposed. Rep. Frank on Sunday referred to lavish executive salaries and bonuses as a "perverse incentive" that encourages executives to take inappropriate or excessive risks in exchange for multi-million-dollar payouts, and therefore, part of the problem.

Paulson finally agreed yesterday, stating that "the American people are angry about executive compensation and rightfully so. We must find a way to address this in the legislation."

The plan will likely include stock warrants that compensate the federal government, and perhaps the U.S. taxpayers, for their investment.

"Right now the price of admission [to the proposed Treasury program] is zero," Sen. Jack Reed, D-RI, said Tuesday. "It's not inappropriate to demand that if they benefit from this transaction in the future … that they will share that benefit with the taxpayers who made the benefits possible."

Money Morning's Gilani can't help but wonder if this isn't a case of too little, too late.
"Everyone knew since at least August 2007 that we were facing an increasingly dangerous credit crisis; that was the shot across our bow," Gilani said. "When Bear Stearns failed in March that was a direct hit and we should have declared war. To now be trying to nuke the crisis with a $700 billion-bomb of legislation just makes me more afraid of the fall-out."

[Editor's Note: Contributing Editor R. Shah Gilani has toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. In his just-completed three-part investigation of the U.S. credit crisis, Gilani was able to provide insider insights that no other financial writer or commentator could hope to match. He drew upon the experiences and network of contacts that he developed through the years to provide Money Morning readers with the "real story" of the credit crisis. It's a perspective on the near-financial meltdown that you'll find nowhere else. If you missed Gilani's investigative series, Part I appeared Friday, Part II ran Monday and Part III was published Wednesday. In his "Open Letter to U.S. Treasury Secretary Henry M. Paulson, Federal Reserve Chairman Ben S. Bernanke, members of Congress and the governor of your state," Gilani details a bailout proposal that he believes will fix the problem quickly and effectively – at little cost to taxpayers. If you like the plan, mail the plan to the leaders of Congress or to the governor of your state.]

News and Related Story Links:

• The Los Angeles Times:
  Lawmakers reach agreement on bailout framework.

• Money Morning Investigative Research Report:
  Dear Hank: Here's How to End the Credit Crisis at No Cost to Taxpayers.

• Money Morning Special Investigation of the Credit Crisis (Part I):
  The Real Reason for the Global Financial Crisis…the Story No One's Talking About.

• Money Morning Special Investigation of the Credit Crisis (Part II):
  The Credit Crisis and the Real Story Behind the Collapse of AIG.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part III):
  How Complex Securities, Wall Street Protectionism and Myopic Regulation Caused a Near-Meltdown of the U.S. Banking System.

• The Associated Press:
  Bailout money would be phased in.

• Bloomberg News:
  U.S. Stocks Advance as Congress Nears Agreement on Bank Bailout

• MarketWatch:
  Stock indexes rally on optimism for bank bailout

• MarketWatch:
  Gold pulls back as investors mull rescue plan

• MarketWatch:
  Oil futures gain 2.2% as bailout plan nears approval

• MarketWatch:
  Bush urges quick action on financial rescue plan

• Reuters:
  US STOCKS-Wall St jumps as bailout approval nears.