Bailout opens door for players

The $700 billion bailout may or may not unclog the nation's financial system.

But what it would surely do, experts say, is create opportunities for clever investors to game the system.

"I think everyone who is in the financial-services business is busting a gut right now trying to figure out where" the money can be made, said Richard D. Jones, a partner at Dechert L.L.P. who focuses on mortgage finance and capital markets.

As the U.S. Treasury Department begins implementing the bailout program - the first contractors might be hired this week - the nation's financial problems only deepened.

Ben S. Bernanke's Federal Reserve unleashed a flood of short-term lending. Treasury Secretary Henry M. Paulson Jr. raised the prospect of direct investments in banks.

Despite it all, stocks had their worst week in years, if not in history.

It is too soon to know precisely where the opportunities lie because the Treasury Department has until Nov. 16 to develop systems for valuing and buying troubled assets, according to Dechert.

The central problem with the program, Jones and other experts said, is that the government as buyer and the distressed companies as sellers are driven by something other than trying to make as much money as possible.

The goverment is trying to prevent the economy from stalling entirely and destroying millions of jobs. Financial companies need to rid themselves of toxic debt to get back in business.

"When players are motivated by something other than yield," Jones said, referring to the return on an investment, "there is serious money to be made."

That dynamic - troublesome or enticing, depending on your viewpoint - is compounded by the lockdown of markets that normally set prices for financial instruments, such as mortgage-backed securities.

The unintended beneficiaries of the government's effort to get those markets working again are likely to be institutional investors and hedge funds.

Not that many financial experts are crying foul.

"There are going to be smart people out there trying to figure out how to make money off this, and they will be able to," Peter Morici, a business professor at the University of Maryland, said. "It won't negate the value of this exercise," he said.

The most direct way to benefit from the Troubled Asset Relief Program - TARP for short - is to be one of the companies hired to run it.

The Emergency Economic Stabilization Act signed Oct. 3 by President Bush requires regulators to prevent conflicts of interest, but that is no small task.

Representatives for two companies often mentioned as likely asset managers for the government - BlackRock Inc. and Pacific Investment Management Co. L.L.C. - had no comment on the potential conflict of interest.

The problem, Drexel University law professor Karl S. Okamoto said, is that the government must hire asset managers with expertise in handling large pools of mortgage-related assets.

Those asset managers will have inevitable conflicts between the funds they manage for the government and the funds they manage for other customers. They could engage in transactions in the government fund that would benefit their other funds by driving the price up or down, depending on the situation, Okamoto said.

The likely stance of the government - focused more on the goal of fixing the economy than on making money - creates greater "opportunity to 'slip a few by' " in a way that benefits nongovernment clients than is usually the case, said Okamoto, who directs Drexel's program in business and entrepreneurship law.

For companies not working for the government on TARP, the first opportunity to game the system will be in the sale of assets to the government, said Robert A. Eisenbeis, chief monetary economist at Cumberland Advisors Inc., of Vineland, N.J.

Eisenbeis said the Treasury Department would have the disadvantage of not knowing as much about the troubled assets as the sellers.

"So the Treasury is going to be plucked clean by those with superior knowledge," said Eisenbeis, formerly director of research at the Federal Reserve Bank of Atlanta.

Jones, the Dechert lawyer, said he could imagine a situation in which the government is offering $300 million for a pool of securities and a private buyer comes along and offers to pay $270 million - with no regulatory constraints, such as those on executive compensation.

That would be a good thing, Jones said, because the point of the program is to get securities priced and sold.

Thomas H. Duncan, a lawyer with Ballard, Spahr, Andrews & Ingersoll L.L.P., said the big money would be made by investors on the back end, when assets are sold back into the private sector.

Referring to his experience dealing with the Resolution Trust Corp., created in 1989 to fix the savings and loan crisis, Duncan said: "The people who were successful there had superior knowledge or superior servicing systems."

Getting good deals from the goverment under this program will be more difficult because most of the assets will be securities rather than whole loans. Nevertheless, "there will be ways to figure it out," said Duncan, who works in Denver.

A factor working against investors is the Treasury's wide-ranging power under the law to make regulations. "It will be very dynamic," said Gregory J. Nowak, a partner at Pepper Hamilton L.L.P. specializing in securities law. "They will try to plug holes."

Olivier Garret, chief executive officer of Casey Research, a publisher of investor newsletters in Stowe, Vt., said people would make money off the program despite those efforts. "There's no question, because the government with its regulation is never going to be fast enough," he said.