Follow the Leader

Story Highlights:

• The US went public with a scheme to provide support capital to financial institutions across the country.
• With a less-noticed increase in Fannie and Freddie spending and a quick, little-debated plan reversal, it's clearer just how much unilateral control Henry Paulson's been granted.

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Falling in line with many other developed countries, the US announced Tuesday a plan to inject some $250 billion into financial institutions in exchange for equity stakes. After Monday's big upward move, US markets ended Tuesday down a little—the least volatile day in weeks. But whatever the short-term outcome, we think the longer-term plan will work fine but unintended negative consequences could eventually ensue—only time will tell.

Notably, not every financial institution was happy about the plan. Not all necessarily need or want the "good graces" of the government right now. But they were pressured by the government to accept assistance in the name of a systemic cure. Like it or not, it appears the plan will go forward as announced—allocating roughly $125 billion to eight of the nation's leading banks: Bank of America (and Merrill Lynch), JP Morgan, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon, and State Street. By supporting a number of institutions at once, the government hopes to avoid casting an uncomfortable spotlight on any one institution. The remaining cash will go to support a broad swath of smaller banks.

In exchange for their capital, the feds will receive preferred non-voting shares paying a 5% dividend (9% after five years) and will also encourage firms to seek private capital by offering sweeter terms for those "returning capital to the government by 2009." Nonetheless, some indication of government tinkering is already evident in the Congress-mandated executive pay restrictions attached to the capital infusions.

The latest action combines with another less-televised piece of news illustrating already dramatic increases in government intervention. The Treasury yesterday gave Fannie and Freddie a mandate to purchase $40 billion of struggling mortgages per month—essentially fulfilling the primary aim of Paulson's plan before the focus shifted toward equity stakes. Such a move quietly (and cleverly) would expand the overall dollar cap for the bailout by perhaps as much as a publicly unapproved $200 billion through next year.

The radical shift in the TARP (Troubled Asset Repurchase Plan) strategy, though endorsed by many in Congress, was undertaken without explicitly seeking their approval or public debate. This isn't all bad because at least it means it won't be nailed to a pork-laden piece of legislation. But it's unsettling that a single man, Paulson, is working with what essentially comes to two blank checks—one publicly declared and another under the table (if you count Fannie and Freddie's new mandate)—totaling close to a trillion dollars taxpayer exposure. In the end, it won't necessarily cost anywhere near that much. But it's an alarming amount of financial decision-making clout to be wielded by one individual and demonstrates just how much unilateral control Paulson has been granted. He is now, in some sense, by far the most powerful man in financial history.