Now, the United States of Enron?

The Washington Post reported on Saturday, April 4, 2009, that, for some bank bailout measures, the federal government is using a funding mechanism that harks back to the Enron scandal, in order to circumvent legal limits on executive compensation and the requirement for a government equity stake in the bailed out institution. Specifically, the government is setting up intermediate entities, called special purpose entities, that would stand between the government and the banks and other private interests participating in the bailouts. The government would fund the SPEs with capital and loans, while private investors would provide an additional amount of capital. Because government money would directly flow to the SPEs, instead of the banks or other firms being bailed out, the limits on executive compensation and the requirement for taxpayer equity would supposedly not apply to the latter, even though they are the real beneficiaries of the bailouts.

If the term special purpose entity rings a bell, it’s probably from something you read about Enron, which ensured that SPEs will live in infamy as devices for concealing risky investments and providing extra, undisclosed compensation to executives. SPEs acquired added notoriety when it turned out they had been used to hold all manner of dicey mortgage-backed securities and derivatives offloaded by banks that wanted to disavow those assets. The irony of the federal government using scandalized investment vehicles for bailouts is so obvious it hardly needs to be mentioned.

Perhaps less apparent, but more troubling, is the governmental weakness it reveals. The administration is seeking capital from the private sector because it does not feel it can go back to Congress for more bailout funds. Wall Streeters can smell weakness the way sharks can smell blood, and have exploited the administration’s weakness to get dispensation to keep doing business as usual for compensation as usual. This sets a dangerous precedent. Increased regulation of financial institutions is in the offing. Will the administration allow banks to continue business as usual through off-balance sheet techniques that circumvent its own increased regulatory oversight?

Congress strengthens Wall Street’s negotiating leverage by engaging in UHF quality histrionics on C-Span instead of a thoughtful review of the problems and issues. Its basement level standing with the public will seep lower than sump pumps can go if it needlessly weakens the president at a time of crisis.

Even if we assume the administration’s SPE structures are legally permitted, they are too clever by half. Once taxpayers realize that the administration has gone out of its way to allow Wall Streeters to eat their cake and have it, too, they will begin to lose faith in their newly elected president.

President Obama has an abundance of political capital at the moment. The electorate trusts him regardless of what fat guys on conservative talk radio say. His toxic asset purchase program might fail. Strong banks could take advantage of it to offload their problem children, and then raise more capital from the private sector. Weak banks might instead take advantage of the FASB’s new, relaxed approach to asset valuation and paint a glowing picture of themselves while actually remaining zombies. The financial crisis could continue largely unabated. Something much more direct, like temporary nationalization of banks, may well be necessary. The president should be prepared to step forward and take the lead on measures like nationalization, and weakening his standing now with potentially controversial SPE structures will only make the ultimate resolution harder.