ANALYSIS:ON WALL Street, it is joked that the problem with financial institution balance sheets is that, "on the left-hand side nothing is right and on the right-hand side nothing is left".
By removing $700 billion (€484 billion) of illiquid mortgage-backed securities from balance sheets, the US government had hoped to remedy that situation.
The Republican congressional revolt against the plan has added to existing concerns as to the ultimate cost for US taxpayers.
The original proposals by US treasury secretary Henry Paulson and Federal Reserve chairman Ben Bernanke had already been watered down, with increased attention given to protecting the taxpayer. Princeton economics professor Paul Krugman said the new plan was "a lot better" than the original incarnation and was "worth passing", a far cry from his initial description of "a giant windfall at taxpayer expense".
The $700 billion was to be disbursed in stages, with an initial $250 billion being released after legislation was enacted.
The origins of the $700 billion figure are vague. A treasury spokeswoman last week let slip that "it's not based on any particular data point" and they "just wanted to choose a really large number". Bernanke has admitted the figure is "not science" and "seems like an appropriate size".
While Congress yesterday balked at the magnitude of the $700 billion package, which amounts to one-quarter of annual US spending, analysts at Credit Suisse were cautioning that "the size of the package is too small".
While the original three-page plan has morphed into a 110-page document, the treasury had hoped to retain discretion over the price it would pay for illiquid mortgage-backed assets. That led to critics complaining that the government would be paying over the odds for trash assets. Bill Gross, manager of the world's biggest bond fund, has warned of the dangers of paying a price that would "screw the taxpayer" or paying a firesale price that "would likely bankrupt some weak institutions and defeat the purpose of the bailout".
Authorities appear to be intent on paying above-market prices, with Bernanke last week saying assets would be bought at "close to hold-to-maturity" prices rather than what he regards as the current "firesale prices". His argument is that the prices are the product of a frozen, irrational market that does not reflect the fundamental value of the assets.
Krugman calls it the "slap-in-the-face theory: markets are getting hysterical, and the feds can calm them down by buying when everyone else is selling". He describes as "bizarre" the notion that Bernanke and Paulson "know better than the market what a broad class of securities is worth".
Both men have been criticised for their predictive abilities, with Paulson predicting 18 months ago that the housing market was "at or near a bottom" and Bernanke last year announcing that subprime troubles were "unlikely to seriously spill over to the broader economy or the financial system". Opinion varies widely as to the package's ultimate cost.
New York University economics professor Nouriel Roubini sees it as a "total rip-off" that would be a "huge expense for the US taxpayer", while Paulson expects losses to be "minimal".
Bradford DeLong, economics professor at the University of California, says it is "within the realms of possibility" that taxpayers might actually make a profit if authorities sell the securities back to the market at a later date.
Uncertainty reigns, and that uncertainty was only added to by the rejection of the Bill by the House of Representatives, with global markets yesterday suffering their worst one-day decline since the MSCI World Index was created in 1970.
