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Climbing From The Wreckage

Shares fell across Asia Friday morning, and all eyes were on Wall Street as investors and political leaders alike sifted through the wreckage left by a wild Thursday, in which Washington again failed to reach agreement on how to break the credit crunch.

Talks were to resume at the Capitol on Treasury’s $700 billion rescue plan, but a high-profile White House meeting ended Thursday on a sour, contentious note after animated exchanges among lawmakers laced with presidential politics just weeks before the November elections.

The political breakdown came as the collapse of Washington Mutual Inc. — the largest bank failure in US history — marked another low point in the financial crisis. And angry Democrats warned that Treasury’s whole initiative could collapse unless President Bush gets House Republicans to come to the table.

“Unless this fourth leg shows up at some point, this could fall off very quickly,” said Senate Banking Committee Chairman Christopher Dodd (D-Conn.).

At the White House, in fact, House Minority Leader John Boehner had bluntly warned about the lack of Republican support for the massive government intervention: “I can’t invent votes,” Boehner said. But House Financial Services Committee Chairman Barney Frank (D-Mass.) angrily accused the minority of trying to undercut Paulson by crafting a late-breaking alternative proposal—with the tacit support, Frank said, of Republican presidential candidate John McCain.

Both McCain and his Democratic rival, Sen. Barack Obama, would leave the White House without comment, and the meeting was described as among the wildest in memory. A beleaguered President Bush had to struggle to maintain order and reassert himself. And when Democrats left to caucus in the Roosevelt Room, Paulson pursued them, begging that they not “blow up” the legislation.

The former Goldman Sachs CEO even went down on one knee as if genuflecting, to which Speaker Nancy Pelosi (D-Cal.) is said to have joked, “I didn’t know you were Catholic.”

It was McCain who had urged Bush to call the White House meeting but Democrats made sure Obama had a prominent part. And much as they complained later of being blindsided, the whole event turned out to be something of an ambush on their part—aimed at McCain and House Republicans.

“Speaking professionally,” said one Republican aide, “They did a very good job.”

When Bush yielded early to Pelosi and Senate Majority Leader Harry Reid (D- Nev.) to speak, they yielded to Obama to speak for the assembled Democrats. And it was Obama who raised the subject of the conservative alternative and pressed Paulson on what he thought of the idea.

House Republicans felt trapped—squeezed by Treasury, House Democrats and a bipartisan coalition in the Senate. And while McCain spoke surprisingly little after asking for the meeting, he conceded that it appeared there were not the votes for the core Paulson plan without major changes.

A top adviser to McCain, Mark Salter, said later that the senator had not endorsed the House conservative plan but felt it reflected a desire by lawmakers for more taxpayer protections that would help get the required votes. For example, Salter said, one option would be to make clear that the secretary needn’t be confined to buying up bad debts and could use other routes such as loans or federally-backed insurance to relieve the congestion in mortgage-related assets.

When talks resumed — in Reid’s words — to "put the train back on track,” Paulson came to the Capitol but without Federal Reserve Chairman Ben Bernanke, who appears to want to stand clear of the negotiating session.

The wild White House meeting may have the effect of uniting Democrats more. And only hours before, Dodd, Frank and bipartisan set of prominent senators had reached a bipartisan agreement Thursday on th framework for legislation authorizing the massive government intervention.

But passing the Treasury plan is still an uphill climb, and Pelosi will be reluctant to expose her members if House Republicans are sitting out the process. And the whole sequence of events confirmed Treasury’s fears about the decision by Bush, at the urging of McCain, to allow presidential politics into what were already difficult negotiations.

While the markets were closed by the time the meeting ended, Friday could bring turmoil, and there will be immense pressure now by Treasury to get back on track before Monday.

McCain could feel that same pressure. Having called for the meeting, he will have to show if can deliver the votes of House Republicans, many of whom have been leery of him in the past. Mindful of this, the senator’s campaign issued a brief statement an hour after the breakup of the meeting.

“We're optimistic that Sen. McCain will bring House Republicans on board without driving other parties away, resulting in a successful deal for the American taxpayer.”

But House Republicans predicted that the bill now may have to move first in the Senate, where it has more bipartisan support. And one outside option would be to add the package to a must-pass year-end spending bill needed to keep the government funded after Oct. 1.

Paulson was left feeling bruised on two fronts. He was not part of the Capitol discussions in the morning, which stretched to nearly three hours and will now require extensive follow-up with Treasury. This process began last night and will continue Friday morning, while the leadership takes the political temperature for going forward.

At the same time, Frank, a strong Paulson ally, feels the secretary is being undercut in front of the president.“McCain and the House Republicans are undercutting the Paulson plan, talking about a wholly different approach,” Frank said prior to the meeting. And this was very much the line of attack at the White House: “This is the presidential campaign of John McCain undermining what Hank Paulson tells us is essential for the country.”

Wisconsin Rep. Paul Ryan, the ranking Republican on the House Budget Committee and one of the authors of the conservative alternative, said that McCain had yet to sign onto the proposal. But Ryan confirmed that he and other House Republicans had met with the Arizona senator on the issue prior to the White House meeting in Boehner’s office.

“Our goal is not to derail. Our goal is to break the logjam. It’s a Plan B if Paulson can’t pass,” Ryan said. “This is such a crisis I’m not going to draw some line in the sand. We can’t leave without doing something, but we don’t think the votes are here for Paulson.”

From Frank’s perspective, this can be a self-fulfilling prophecy since Republicans will be able to peel off the administration plan and claim they are still taking action. “Nancy is not going to pass a bill with Republicans having an excuse to vote against it,” Frank said of Pelosi. And given the cost of the Treasury plan, Democratic leaders have warned that they will want at least a healthy Republican showing of 80 to 100 votes if they are going to ask their members to vote with the president.

Frank and Dodd said they are open to further changes in their draft bill to meet Paulson’s concerns. But both chairmen saw the Capitol meeting Thursday morning as providing a real bipartisan foundation for progress this weekend.

“We think we have fundamental agreement on a set of principles,” said Dodd. “We’re very confident we can act expeditiously, and we’ve done a good job arriving at that kind of consensus.”

Those principles will include improved oversight of the program, as well as a plan to phase in the $700 billion investment in stages, while still assuring the administrtion a virtual free hand for at least the first $350 billion.

There is a greater emphasis on efforts not just to relieve Wall Street firms of their bad debts but also to help homeowners threatened by foreclosure. Companies that benefit from the plan would be expected to limit pay and severance packages for their executives, and community banks are expected to benefit from a new $3 billion tax break as a result of their stock losses in the government takeover of the two mortgage finance giants, Fannie Mae and Freddie Mac.

Prior to the White House meeting, Sen. Bob Bennett (R-Utah) predicted legislation could be finalized in time for Congress to act this weekend. Sen. Judd Gregg (R-N.H.), who continued to represent Senate Republicans Thursday night and has close ties to the White House, conceded that portions of the package won’t be to Treasury’s liking, but the agreement was a step forward.

“There are things they won’t be comfortable with — obviously there was a lot of give on both sides,” Gregg said. “ I think they may be very concerned about some sections of it, but the overall thrust of it will be to give them the authority they need to address the underlying problem, which is to get these securities out of the blocking pattern that they are in, relevant to the credit markets. This will allow the Treasury secretary to go and clean up the credit markets using basically tax dollars.”

Paulson had asked for the $700 billion funding authority as part of his initial bill, arguing that the large number is an important signal to the markets of the government’s commitment. Nonetheless, the administration has since paid a heavy political price for not better explaining its initiative as an “investment” by taxpayers — and one which will surely be repaid to some level as the economy improves.

The whole debate has exposed an angry anti-Wall Street cultural divide, and Paulson, a former Goldman Sachs CEO, has been the target of critics who argue that “Main Street” taxpayers are being asked to aid other wealthy bankers. Getting the full $700 billion, without any encumbrances, has become almost impossible politically in Congress.

The proposal agreed to in the Capitol meeting would allow $250 billion, immediately followed by another $100 billion, for a total of $350 billion. What happens to the second $350 billion is sure to be the subject of intense bargaining still with Treasury. But lawmakers signaled that Congress would have the authority to deny any more money through a joint resolution — but that it would have to overcome a presidential veto to do so.

Treasury has raised concerns, but much will depend on how the markets react to this phased-in approach to the funding.

In testimony this week, Paulson and Bernanke have emphasized that the government will proceed carefully — suggesting that not all the money is needed up front, in fact. But the administration and Federal Reserve officials argue that the psychological impact of the $700 billion commitment is important in itself, and Treasury will want to be sure it has access to the second $350 billion.

The cost debate illustrates just how nuanced the massive intervention will be. Paulson has often stumbled this week when trying to describe its intent, and the clearest voice has been Bernanke, a former college professor who casts the whole effort as an unprecedented experiment in “price discovery” that will add not just capital but also precious knowledge to jump-start the credit markets.

With the bursting of the U.S. housing bubble, mortgage-related securities are caught in a vicious downward cycle, commanding only “fire sale” prices, Bernanke says. The government purchases, through a series of novel auction mechanisms, will help the market value these assets, he says. And this could be the spark needed to get markets working and the economy&rsqo;s engine turning over again.

This explanation is very different from the “bailout” imagery that surrounds the debate. And the great challenge for both sides has been to find some path in between these two poles — able to satisfy the anger voters feel toward Wall Street but also leaving enough room for Bernanke’s experiment to function.
One issue where this comes up is the question whether Treasury should demand warrants or options to hold stock in the companies — a way, perhaps, to turn a profit for taxpayers in the future. Many Democrats argue that this is only fair given the risk the Treasury is assuming by buying up the bad debts. But Bernanke worries that it will be seen as a punitive step and discourage companies from participating — and thereby reduce the competition in the market.

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