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I was speaking to a standing-room-only crowd at a North Carolina investing conference recently when a sharply worded question soared over the group from a gentleman seated in the back row – and who was clearly agitated by my analysis of the whole bailout plan situation.

“How would you have handled it differently, Mr. Smarty-Pants?” he asked, in a challenging voice.

What I’m about to say is academic because – when it comes to the bailout plan – “Bernanke, Paulson & Co.” has already made up its mind.

I believe Paulson actually missed a historic opportunity to remove U.S. taxpayers from further financial troubles rather than lump more debt on them, just as I believe Bernanke missed several opportunities earlier this year.

By appointing the Federal Housing Finance Authority [FHFA] as a conservator, U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. has essentially assigned the FHFA to be the legal guardian of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). And that’s good, since conservatorships are typically established when a company can’t take care of itself and is considered incapable of handling its own affairs.

In this instance, both Fannie and Freddie qualify as not only being incapable, but perhaps even criminal as well, after hemorrhaging capital over the past 12 months. And this situation was even more complicated than it initially appeared, since there were global implications. As Money Morning detailed in a special report, it was pressure from foreign bondholders that finally forced the U.S. government’s hand.

Unfortunately, conservators can rarely do anything more than keep the lights on. As the term implies, they’re intended to “conserve” assets and property, until they can return the entity to solvency.

So, despite Paulson’s fancy plans and the $200 billion capital infusion he’s lined up, he may have handed hollow authority to an agency that cannot, for all intents and purposes, assign, strip, liquidate or materially alter how either Fannie or Freddie operates. Nor can conservators typically take possession of assets, which is a critically important distinction in this instance.

On the other hand, receivers are typically entrusted by the courts, or secured creditors, specifically to take possession of troubled assets and to dispose of them in a timely manner, and in such a way that they maximize returns to the secured creditors. And in the case of a public company, that duty theoretically extends to the company’s shareholders, as well.

In that sense, rather than placing an emphasis on continued operations as a conservatorship, a receivership emphasizes a return on capital and the cessation of operations.

In my opinion, that’s what’s really needed here.

Were I running the show, I would have assigned the FHFA (or brought in some true bailout specialists) to act more as receivers than as conservators. With that accomplished, I would have taken three key steps:

  • First, instead of making a $200 billion down payment on the mother of all mortgages, I would have charged the receiver with immediately separating “good” debt from “bad” debt.
  • Second, I would have ordered the receiver to weed out and repudiate flawed contracts.
  • And, third, I would have searched for a way to sell Fannie and Freddie common and preferred shares in such a way that it would minimize taxpayer losses, rather than make them potentially unlimited as Paulson’s done.

Apparently, FHFA Director James B. Lockhart III does have the discretion to place Fannie and Freddie into receivership if he determines that’s the move that’s required, but the eventual dissolution could only take place by Congressional Act. That makes such an outcome highly unlikely, to say the least, given how much “pork barreling” has historically been linked to the two companies and to the financial industry in general. Despite the fact that liquidation – rather than keeping the lights on – is exactly what’s needed in my opinion.

I find it terribly sad that Paulson is going to throw $200 billion, or more, of taxpayer money into a black hole that’s already consumed billions. Especially when he’s publicly admitted that regulators don’t know enough about the complex financial derivatives and off-balance-sheet investment vehicles that have forced the bailouts of some of the world’s largest banks, forcing the U.S. Federal Reserve and U.S. Treasury Department to travel deep into uncharted waters.

It would seem that cutting our losses short is a far more productive option, especially when it minimizes potential taxpayer losses from the “unknown.”

It would also appear that Paulson has opted for the easy way out by socializing losses and allowing gains to remain private. Some will say that’s the way it’s always worked and that I’m naïve for thinking that it could somehow be different this time. Perhaps that’s the case. But I also believe this country’s financial situation cannot be stabilized by stopgap measures and half-baked bailout plans.

Nor do I think that running up even more debt in the face of the unknown is the direction to travel. I need only point out that the initial Office of Management and Budget estimates for the Iraqi war were a mere $50 billion.

I believe that Paulson could have been a hero by engineering a true workout that maximizes any remaining shareholder value. Instead, he’s structured $200 billion, or more, in preferred stock, and warrants that may never be paid back and that are effectively worthless unless Fannie and Freddie return to profitability.

And with the broad-based bailout he proposed a week ago – and that Congress is now sculpting into another shape – he’s effectively added another $700 billion to the U.S. bailout tab. In short, we’re talking about a flawed “fix-it” plan that’s going to cost you and I nearly $1 trillion.

Adding insult to injury, the relatively few individuals who engineered this whole mess with implicit government support are apparently going to be allowed to ride into the sunset with their saddlebags packed full of taxpayer money. Or at least with the millions of dollars they reap from their “golden parachute” corporate-severance packages. Either way, they’re not going to suffer like the U.S. taxpayer will. And that suffering will last for a long, long time.

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Source: 3 Key Steps to Fix This Fiasco