Let's not rush to blow $700 billion

Take just one example: the creation of false prices. A financial company that is required to mark the prices of the securities in its portfolio to the levels paid during real trades can create artificial prices if it colludes with traders to buy those securities at an inflated price. All it takes is one trade, especially in a thinly traded security, to create a price far above the real price.

This practice is what landed former Enron CEO Jeffrey Skilling in prison. And there's no doubt that in the run-up to this crisis some financial companies used questionable prices to inflate the value of their portfolios so they could borrow more money to buy more securities and derivatives.

With the Treasury looking to buy damaged securities and derivatives that aren't trading at all right now, the temptation to create a false price would be greater than some financial companies could resist. Especially if they knew they wouldn't be prosecuted unless Treasury officials focused on getting the market working were willing to bring a case and rock the boat. Investors or taxpayers who were cheated in this process would have no legal recourse.

No. 3: Don't let the drunks drive again

Managing a $700 billion portfolio of damaged securities and derivatives is way beyond the capability of the Treasury. The plan now is to farm out that work to, you guessed it, the Wall Street experts who helped create this crisis. That's absolutely, 100% WRONG.

At the moment there are no credible standards to prevent conflicts of interest. Would an expert manager be tempted to inflate the prices of the damaged paper held or issued by the expert's company? Of course. What would keep these managers honest? The oversight that the Treasury proposal makes impossible? How about fees? These experts wouldn't do their work for free. Who would decide what constituted a reasonable fee for these services? Treasury again. Without any oversight.

Congress could take a shot at fixing these problems and others -- this is by no means an exhaustive list -- even though most members of Congress don't know a derivative from a doughnut. The major financial committees have staffs that, given a reasonable amount of time, could come up with regulations that improved the workings of the financial markets and take temptation to manipulate prices and fees out of the reach of Wall Street.

But the chairman of the Federal Reserve and the secretary of the Treasury say Congress doesn't have the time to waste on such superficialities. If Congress doesn't act this weekend, they say, the consequences are too dire to imagine. By and large, the financial pundits have echoed this view.

To which I say: That's absolutely, 100% WRONG.

Did haste equal $85 billion waste?

The lesson of the crisis solutions from the Treasury and the Fed so far say haste is exactly what we don't need. For example, because the Treasury didn't nail down the details of the AIG rescue, the company last week was able to send two letters to the Securities and Exchange Commission that took contradictory positions on whether taxpayers would get equity in the company and whether the $85 billion loan required approval from company shareholders. If that's the level of detail that escapes the Treasury and the Fed when they're doing one $85 billion deal in haste, I don't see any reason to rush to give them access to $700 billion.

A few financial experts have even suggested that the decision by the Treasury and the Fed to force Lehman Bros. (LEHMQ, news, msgs) into bankruptcy created the collapse of AIG. They argue that the failure of Lehman critically undermined confidence in the derivatives market and led to a massive margin call on the insurance giant.

I don't know whether those critics are correct, but it does raise the best argument against the haste that Paulson and Fed Chairman Ben Bernanke advocate. These markets are incredibly complex, and the dangers of doing something that doesn't work or that has an effect opposite from the one intended are very real.

The Treasury and the Fed have proposed using $700 billion of taxpayer money to buy damaged securities and derivatives. They believe this will help end the crisis in the financial markets by putting prices on currently unpriced paper so that everyone will know what these securities and derivatives are worth. That's a good thing, Paulson and Bernanke say.

But is it? Their assumption is, at the very least, open to question. The only thing keeping some financial companies from having to raise massive amounts of new capital is the unavailability of prices on big hunks of their portfolios. If they had to mark what they hold to market, they'd suddenly be in danger of falling below minimum capital requirements. The solution to that, of course, is to raise more capital in the financial markets. But it's exactly that new capital that isn't available in the markets right now. Ask Lehman and AIG.

Continued: Last line of defense

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