Leaving Nashville and the wonderful Hermitage Hotel On Tuesday I lucked onto the Senate Banking Committee Hearing with Bernanke from the Fed, Paulson from Treasury and Cox from the SEC. The entire meeting was broadcast on Sirius from Bloomberg, uninterrupted for over three hours. I felt like I got a semester’s worth of economics.

The Senators from both parties asked penetrating questions about the bailout and the political blame game was largely absent; the stakes and the urgency were just too great.

Here were a few of the points I can remember. Expect a lot of paraphrasing.

The main purpose is to protect the taxpayer. Paulson kept returning to this focus. Many senators sought to protect the homeowners from foreclosure. Paulson commented that while this was regrettable, some home owners were in houses they could not afford and could not be protected. Some of the senators wanted steps taken to punish the executives and companies who caused the mess.

While Paulson was equally outraged over the unfairness of some of the previous compensation paid to executives who had failed, his focus remained on saving the taxpayer from further damage. Many of the senators questioned what could be done to either get back previously paid bonuses or how to keep large bonuses from being paid to executives of some of the failing firms. Paulson noted several instances where golden parachutes will not be permitted, board fees will not be paid and how many of the shareholders will not be made whole. Retrieving bonuses paid in previous years may be a tougher accomplishment, and will not likely happen, unless outright fraud can be proven in a court.

There were several questions about how the auction of the assets would be handled. Bernanke said it would be a reverse auction which some of the senators probably did not understand. Their concern was that the Treasury armed with $700 billion in a market with few other bidders would just pay too much.

Bernanke explained that the mortgages had two prices; the fire sale price and the hold to maturity price. The cause of the liquidity crisis was that the banks under current regulations had to mark their assets to market which is currently the fire sale price. This reduces their ability to lend money to borrowers and causes the liquidity crisis.

Many of these mortgages will be held to maturity and are worth more than the fire sale price. But the market is in a decline and some fo the instruments are complicated and the market for them is so thin that there appears to be no market for them. By providing a floor and a market the Treasury bailout gives the banks an opportunity to get the non performing assets off their balance sheets.

Chuck Schumer wanted to know why the bailout amount had to be so high. Why could they not get a portion of it now and ask Congress for more if it appeared to be working? Paulson said that this would be disastrous, that the market needed reassurance that this problem could be fixed and that the commitment was solid. There are many unknowns and he did not want them to surface urgently while the Congress was in recess.

The amount would not be spent all at once, but would be truncated. They would probably group asset classes together when they were bought. Schumer also questioned the need for an FDIC type vehicle funded by premiums paid by the largest institutions. While this could be a part of future reform, Paulson indicated it was not nor should be a part of the bailout.

Senator Bayh questioned why private equity should not be required to participate in the auction, even to a point of only 10%. Paulson said that the more restrictions and the less flexibility that was put on the auction the less the chance of its success.

In creating a market, the Treasury will be buying the mortgages and selling them on the market in some measured way, as it did during the Resolution Trust Corporation (RTC) unwinding of the assets of the S&L fiasco. While they would expect to get much of the money back and could possibly earn a profit on the bailout, this depended on the unfolding of the housing market that was still uncertain and such an outcome could not be guaranteed.

Bernanke, a student of financial disasters, noted that this instance was different than bailing out a bunch of failed companies. The purpose here was not to keep a bunch of companies alive that were too big to fail, but to assure liquidity to the market to prevent an overall economic collapse and widespread unemployment.

Paulson, contrary to published reports to the contrary, expected and welcomed Congressional oversight and transparency; but the current plan is only an outline and there are many details to be worked out on its execution. All three noted urgency and that any effort to ‘attach’ items, become too punitive, or reduce flexibility to respond could be disastrous.