Government's bailout path a maze of unknowns

With congressional passage of the bailout bill Friday, the financial industry's focus will shift to the mechanics of the deal: How exactly does the government plan to spend up to $700 billion to buy troubled loans from banks?

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.

"Someone who controls $350 [to] $700 billion can determine who survives and who doesn't," said Lawrence E. Harris, a finance professor at USC and the former chief economist of the Securities and Exchange Commission. "That's a massive amount of power that has the potential for, if not fraud, then favoritism and blind mistakes."

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.

Pricing the assets

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.

Harvard Law School professor Lucian A. Bebchuk suggested in a recent paper that the government divide its fund into, say, 20 equal portions and promise the manager of each a set percentage of the profit generated by his or her purchases over time.