The Treasury can choose how to finance this purchase.

First though, the plan gives us insight into when Treasury foresees the US Economy recovering. If all preferred shares are callable in three years, but only redeemable through equity (and not debt) prior to, then in essence, Treasury believes we will not fully calm the credit markets until three years from now.

At present, The Treasury issues 2 Years, 5 Years, and 10 Years. Yet Treasury must know most banks will call the preferred shares by year five when the dividend percentage increases from 5% to 9%.

Yet how many banks will take out the preferred shares prior to year three? Probably not many.

The safest debt instrument then is a five year treasury debt instrument. Here is why:

• The Yield on Five Year Treasuries is 2.609%, cheap money.

• No refinance risk. The preferred shares are retired back piece by piece through the next five years. While there is a chance of buying back treasuries at a premium when the debt is retired, the debt is so cheap; this problem is hard to imagine.

• Isolates the problem to the current administration. No doubt, models exist predicting when various banks will pay back the preferred shares, estimating duration and a possible combination of two year debt, five year debt and accept some refinance risk if funding is further needed.

Hank Paulson is a graduate of Harvard Business School, my cross town rival. (I went to MIT Sloan).

As 60 minutes shadowed him prior to the Congressional Approval of his bill, he was a leader handling a crisis:

1. Keep calm
2. Keep the solution simple
3. Execute the simple solution

So he must have known using the Treasury Department to buy asset back securities would be challenging, painful, and timely.

Today, the Financial Times, the New York Times, and the Wall Street Journal are all reporting the Treasury Department is considering equity stakes in banks, rather than purchasing asset backed purchases.

This solution, proposed and scoped early last week in our Third Note, is simpler and more effective.

1. Take equity ownership,
2. Ease capital constraints,
3. Start working through this mess.

On Timing, Hank has no choice.

If a bank asked you for a debt investment of 10 years, would you say yes? At what rate? Most banks are having real problems rolling over their long term debt. Sans long term debt, banks must use short term LIBOR, crippling our working capital system.

Yesterday, US Overnight LIBOR closed at 5.375%, up 1.48% for the day.

Hank, it is time to hit the reset button.

What are the current issues with the bailout plan?

1. Banks will not dilute their equity to the government.
2. The US Congress wants bank equity and further, does not trust Hank Paulson to buy the best CDSs, CMOs, CLOs, and other toxic assets to make the bailout profitable for the taxpayer.
3. We are running out of time. If we do not get a deal done soon, imagine, just imagine what the butterfly spreads on LIBOR at the end of 2009 will look like as banks try desperately to shore up their capital at the close of earnings season.

So let’s act quickly and rationally, using a mechanism we currently operate every day.

Every time the Treasury sells debt to finance the US Government, it runs what is known as a Dutch Auction.

1. It announces how many billions of bonds it intends to sell
2. Everyone intending to buy the bonds bids
   a) An amount
   b) A yield on that amount
3. The Treasury fills its order selecting the best yields and amounts. (for full disclosure, once the Treasury has reached its amount, the highest yield becomes the single yield for all auctioned securities.)

This mechanism is a perfect solution for our current bailout. In short, here is how it would work.

1. The government auctions off a $500 Billion of Equity ($700 may be too much).
2. Registered banks and insurance companies submit anonymous bids of
   a) An amount of capital
   b) A percentage stake of equity stake in each company
3. The Treasury would fill its auction by selecting the best bargains for its dollars.

Once the auctions are awarded, the selected companies would be allowed to do the following:

1. Choose if the awarded money will be preferred equity or common equity
2. If it is preferred, the rate should be floating against current 10 year treasury rate. This should reflect the new marginal cost the taxpayer now incurs to finance the government.
3. If corporations choose to redeem the preferred shares they can buy back the shares at cost plus the current 10 year treasury yield times the share value. The funding would be used to immediately retire treasury debt.
4. If the shares are common, the government can choose to sell these equities at any time or participate in any buy-back plan.

The benefits are as follows:

1. The Taxpayer now owns a share of all banking and economic activity and better, is protected against government borrowing costs.
2. Banks, now with more capital, can write down their subprime assets.
3. In addition, with the participating option, banks need their subprime assets to perform only as well as the treasury rate times the equity they receive. Once they receive their required capital, they can write down their assets to perform as well as a marginal treasury rate.
4. Finally, no one needs to buy anything but equity in banks and insurance companies. If physicists, mathematicians can’t value these assets, let’s not even try. We could administer this auction by election day, move on, and stave off a recession.

Let’s end with a story.

Once, as a broke college student, I attended a church supper with a good friend. After supper was cleared, the entertainment turned to a lottery game, which worked the following way:

1. Everyone who wanted to participate bought a raffle ticket
2. Every round would consist of the Minister drawing a ticket from the bowl
3. If your raffle ticket was selected, you were eliminated from the game
4. Before the beginning of the new round, the remaining entrants could choose to end the game, but only unanimously, and then split the money.

Now, in the early rounds when there were roughly 100 people playing, no way would there be consensus to end the game. But sure enough, as the numbers dwindled down to six or seven, a decision to collude was reached. As a champion of that decision, I too walked away with $300, enough to pay my bills for that month of school.

One by one as the Government works toward a solution, banks are failing and being sold off at miniscule values to the equity holders, eliminated from the game. First it was IndyMac, then Bear Stearns, then Lehman, then AIG, then WaMu and finally yesterday, Wachovia (who by the way, only a week ago had its chairman on CNBC saying how great Wachovia was going to be when it emerged from this crisis).

Maybe they’ll now be few enough to collude in this fashion and take the money as equity, letting us all move on.