For Treasury Dept., Now Comes the Hard Part
By MARK LANDLER and EDMUND L. ANDREWS, NY Times, 10/04/08
WASHINGTON — It will be one of the world’s largest asset management firms with an impressive $700 billion war chest. Nothing short of the global economy depends on its success. And the Treasury Department has barely a month to get it up and running.
The bailout bill that President Bush quickly signed into law on Friday must do what financial experts have been unable to do for the last year — put a dollar value on mortgage-related assets that no one wants, move them off the books of ailing banks and unlock the frozen credit markets.
In signing the measure, Mr. Bush warned Americans not to expect instant results. “This will be done as expeditiously as possible, but it cannot be accomplished overnight. We’ll take the time necessary to design an effective program that achieves its objectives — and does not waste taxpayer dollars.”
Even after working feverishly over the last two weeks, the Treasury will not buy its first distressed asset from a bank for roughly six weeks, and almost certainly not until after the Nov. 4 elections.
Treasury officials do not plan to manage the mortgage assets on their own. Instead, they will outsource nearly all of the work to professionals, who will oversee huge portfolios of bonds and other securities for a management fee.
The Treasury is expected to name a senior official to supervise the program. For now, various working groups creating the program are reporting directly to Henry M. Paulson Jr., the Treasury secretary.
Mr. Paulson has recruited several former colleagues from Goldman Sachs to advise him, though administration officials took pains to say that they were not dominating the process, pointing to other Treasury employees who were playing major roles.
“We will move rapidly to implement the new authorities, but we will also move methodically,” Mr. Paulson said in a statement after the House passed the bill on Friday.
The government will hire only a bare-bones internal staff of about two dozen people with expertise in asset management, accounting and legal issues, according to administration officials, and will outsource the bulk of the program to 5 to 10 asset management firms.
Administration officials said they had not yet selected the list of firms to run auctions or manage the assets. During the last few weeks, the Treasury has informally consulted major firms — including BlackRock, the Pacific Investment Management Company and Legg Mason — but none have been given a mandate, they said.
The selected asset management firms will receive a chunk of the $250 billion that Congress is allowing the Treasury to spend in the first phase of the bailout. Those firms will receive fees that are likely to be lower than the industry standard of 1 percent of assets, or $1 for every $100 under management.
Administration officials said they would try to drive down fees with a competitive bidding process. But with $700 billion to disburse, the plan could still generate tens of billions of dollars in fees if the firms negotiate anywhere close to their standard fees.
The main mechanism for buying these assets will be reverse auctions, using the same principles that govern auctions of electricity or the wireless spectrum. In this case, the government will issue an offer to buy a class of assets — for example, subprime mortgage-backed securities — with the final price being determined by how many banks are willing to sell.
Using outside contractors on such an extensive scale raises a host of thorny questions, outside experts said. Among the most pressing is: How will the Treasury avoid conflicts of interest that fund managers will encounter as they work both for their own clients’ interests — which could pay higher fees — and the interests of taxpayers?
“With anyone short of the stature and honesty of a Paul Volcker running it, you need to worry a lot about conflicts of interest,” said Alan S. Blinder, a former vice chairman of the Federal Reserve, referring to its former head. “Unfortunately, there just aren’t many people with the expertise you need but without any possible conflicts.”
The Treasury officials said they were still writing a policy on conflicts of interest as well as guidelines on compensation.
As if the mechanics were not daunting enough, Treasury officials need to make wrenching decisions that will determine the bailout’s winners and losers. With so much money on the line, lobbyists for interest groups are already besieging the government to decide in their favor.
The prospect of pitching in during a national crisis has drawn unsolicited offers from prominent asset managers, like William H. Gross, the managing director of Pimco, who offered his services free.
In setting up the program, Mr. Paulson has relied on a cadre of former Goldman Sachs executives: Edward C. Forst, a former co-head of Goldman’s investment management business who is on leave from his job as executive vice president at Harvard; Kendrick R. Wilson III, formerly chairman of Goldman’s financial institutions groups; and Dan Jester, who was deputy chief financial officer at Goldman.
But administration officials said several other Treasury officials were playing crucial roles, including six assistant secretaries: Peter B. McCarthy, Phillip L. Swagel, Neel Kashkari, Kenneth E. Carfine, David G. Nason and Kevin I. Fromer, who led the Treasury’s negotiating team on Capitol Hill.
Mr. Forst is expected to soon return to Harvard, where he helps manage its endowment fund. And with a change in administrations looming, many of the people involved in organizing the program will not be around to manage it.
Still, the Treasury may not have trouble recruiting replacements, given the job losses that have plagued the finance industry.
“There are a lot of people, because of the downsizing of Wall Street, who won’t be getting a paycheck at all,” said Joshua S. Siegel, the managing principal of Stone Capital Partners, a fund that manages $2.2 billion. “They would love to be involved.”
Of all the challenges that the Treasury faces, the trickiest might be determining a price for the largely unwanted wreckage it will be buying. Many of the junk loans and mortgage-backed securities have no market price at all because they have no potential buyers. The firms hired by the government will have enormous power to push the “market” price up or down as they choose.
If the government bargains to buy at the lowest possible price, it will protect taxpayers. But forcing the banks to book big losses could be self-defeating if they cannot resume lending until they raise fresh capital. If the government agrees to buy the assets at the value at which banks are keeping them on their balance sheets, taxpayers will almost certainly be overpaying.
The “right” price will depend on whether the government is favoring buyers or sellers. Many banks are hoping that the government will pay close to par — the value listed in their books.
But hedge fund managers and other potential buyers are demanding that the government push for the much lower price, based on the current trading value of the assets. These potential buyers are hoping they can piggyback onto the Treasury program, perhaps even acquiring distressed assets alongside the Treasury in auctions.
There are similar debates over how the Treasury should organize the plan. Most financial experts agree it would be impossible to build an internal operation of this size in a few weeks.
“It’s essential they outsource almost everything possible,” said T. Timothy Ryan Jr., president of the Securities Industry and Financial Markets Association. “The one thing they can’t outsource is the final decision, and they can’t outsource the infrastructure — people, hiring policies, contracting rules. But they can hire people to do everything else.”
Mr. Ryan is a former director of the Office of Thrift Supervision, where he played a key role in the savings and loan cleanup. Still, some investors are troubled by the government’s heavy reliance on private firms. They said it would be difficult to prevent firms from steering capital in ways that favor their private customers.
Inevitably, large asset management firms own, or are tied to banks that own, some of the same securities the government is seeking to sell. Pimco, for example, is owned by Allianz, one of Germany’s largest insurance companies. Merrill Lynch owns a stake in BlackRock.
“I can’t even fathom how I would manage that,” Mr. Siegel said. “How would I manage one side, where I’m seeking to maximize profit, and the other side, where I’m looking out for the social good?”
The law stipulates that the government must prevent conflicts of interest in the hiring of firms, the decision of which assets to buy, the management of those assets and even the jobs held by employees after they leave the program. But it leaves the details to the Treasury.
The Treasury plans to publish guidelines for hiring the asset management firms in the next day or two, officials said. Some experts say that the department simply needs to gird itself for protests.
“You’re never going to get past conflicts of interest, so you take your lumps,” said Peter J. Wallison, who was general counsel of the Treasury during the Reagan administration.
The bailout legislation itself highlights the contradictory goals that the Treasury will face when it goes on its buying spree. Among the goals it is supposed to consider are “protecting taxpayers,” “preventing disruption to financial markets” and “the need to help families keep their homes.”
Democratic lawmakers insisted that the Treasury use its authority to help restructure many subprime mortgages so that at least some troubled homeowners could avoid foreclosure.
But the Treasury’s auction plan will make that difficult. More than 90 percent of all subprime mortgages are part of giant pools, or trusts, which sell mortgage-backed securities to investors around the world.
Before the government would be able to modify any mortgage that was in a trust, securities experts said, it would have to acquire agreement from 100 percent of the bondholders. But a senior Treasury official said the government would probably want to buy no more than half of the securities tied to a trust, which would hamper winning agreement from all investors.
Treasury officials have emphasized that the government will also be buying up whole mortgages, which have not been securitized, and that it may well buy whole mortgages through one-on-one negotiations with individual banks. Officials said they would probably experiment with other approaches as well.