The Dangers in Outsourcing the Bailout

A number of leading Democrats and Republicans expressed strong misgivings on Monday about the autocratic plan for bailing out Wall Street that Treasury Secretary Henry Paulson wants to ram through Congress. It remains to be seen whether this is mere posturing or serious opposition.

Critics are focusing on vital issues such as cost and oversight, but a lot less attention is being paid to the mechanics of Paulson’s proposal – specifically, the question of who would carry out the federal government’s purchase of $700 billion in “troubled” securities from banks. As I noted in my post on Sunday, the draft legislation circulated over the weekend includes a provision that seems to allow Treasury to contract out the process. Treasury then put out a fact sheet making it quite clear it intends to use private asset managers to manage and dispose of the assets it acquires, though the document does not specifically allude to the purchasing. Paulson himself referred to the use of “professional asset managers” during an appearance on one of the Sunday morning talk shows.

It amazes me that there is not more outrage over this aspect of the plan. Paulson seems to be leaving open the possibility that the same firms that are being bailed out could be hired to run the bailout. This would mean that institutions receiving a monumental giveaway of taxpayer money could turn around and earn yet more by acting as the government’s brokers. Aside from the unseemliness of this arrangement, this would be an egregious conflict of interest.

The alternative proposal floated by Senator Chris Dodd, which accepts Paulson’s language on contracting out, includes a section on conflict of interest. But rather than stating what the rules should be, the draft leaves it up to the Treasury Secretary to do so. There were reports on Monday night that Treasury would go along with the inclusion of a conflict-of-interest provision.

Paulson’s approach to the Big Bailout, particularly the insistence that there be no punitive measures for the banks, shows he is not the right party to oversee ethical issues. Paulson apparently can’t help himself. He still has the mindset of a man who spent more than 30 years working on Wall Street, at Goldman Sachs. He is a living example of the perils of the reverse revolving door: the appointment of a private-sector figure to a key policymaking position affecting his or her former industry.

The weak conflict-of-interest provisions Paulson is likely to impose would probably not address the inherent contradiction in having for-profit money managers running the bailout program. Even if Treasury chooses managers whose firms are not getting bailed out, there is still the danger that they will use their inside knowledge to benefit their non-governmental clients (and themselves) or will collude with buyers to the detriment of the public.

A Reuters story that ran on Monday reported that a leading contender for a federal money management role is Laurence Fink and his firm BlackRock, which was involved in managing the portfolio of Bear Stearns when that firm was sold to JPMorgan Chase as part of an earlier bailout. Last March, BlackRock, which is 49-percent owned by Merrill Lynch (now part of Bank of America), announced it was forming a venture to “acquire and restructure distressed residential mortgage loans.” Will Paulson see that as a conflict of interest – or more likely as a credential?

Letting financial firms that have profited from the mortgage crisis manage the bailout gives the impression that we are permanently in the grip of Big Money. To Paulson’s way of thinking, that’s not a problem, but it could make a bad plan much worse.