Let’s say that you are buying a house in a foreign country where you do not know much about the real estate markets and therefore prices are fairly opaque to you. You decide to hire a real estate broker to help you find and buy a house and to act as a guide to the market. You know that real estate brokers sometimes represent the person selling a home as well as a person buying a home, but also know that your broker has a legal responsibility to act in your best interests and disclose as much about the house as possible. Ultimately, the broker makes money on the deal, but does not have a direct financial interest in the house.

So you meet with the broker, who shows you a plain apartment in a plain apartment building. You decide to go for it. He says he will hire an independent home inspector to appraise the home, to make sure it is sound and to help you determine your bid. The process moves forward, you buy the house and pay the broker his fee.

But just months later, you find out that the neighborhood is drug-addled and the apartment filled with leaks. You try to sell the apartment, but can only do so at a 90 percent loss. It turns out that the third-party independent home inspector had been hired by the seller; that the seller had made a bet with a bookie that the price of the house would go down; and that the broker knew it — he let them overvalue your house.

In this analogy, Goldman is the broker. Paulson is on the short side of the trade, and behind the home appraiser. The analogy is by no means perfect — collateralized debt obligations are more complicated than houses. But it goes to show that the issue here was that Goldman had a responsibility to disclose pertinent information to the buyer, and it did not.

Certainly Hank Paulson doesn’t want to have the death of GM happen on his watch, considering unemployment is already at a 26-year high, the financial markets in dire straights and foreclosures are trudging on right through the holiday season.

No details yet, will report as they come.

The question crossed my mind after New America Foundation’s Ellen Seidman described as “really inept” a news conference on Tuesday by Treasury, Fannie Mae and Freddie Mac, to announce a new program to streamline loan modifications. Seidman said Treasury completely oversold the plan, to make it seem like it would cover more mortgages than the plan actually called for. Then, to make it worse, the Treasury spokesman ran out of the briefing room to avoid answering questions.

Felix Salmon at Portfolio seems to have an explanation for all this, and it’s one that totally makes sense to me. Paulson is a lame duck, and the folks at Treasury are going to do whatever they feel like before he leaves office. From Salmon

There does indeed seem to have been a visible change in Treasury policy since the election. Until that point, it cared a little about optics. Now, it’s giving monster bailouts to the likes of AIG and American Express; it’s dragging its feet on homeowner relief; and in general Hank Paulson’s Wall Street buddies seem to be getting much better access than anybody in Detroit. And no one’s even trying very hard to defend these actions in public: they know they’ll be out of a job in January anyway, so they’re just doing what they want to do and what they feel is right, without caring much whether anybody else agrees with them

So much for those warm and fuzzy stories about how the Bush Administration is working hard on a smooth transition.

That’s a dramatic departure from the transition process for most new presidencies. But these are unusual times, with the economy on a precipice. There’s little for the White House to do on most policy matters in the next 11 weeks — but 11 weeks is “a lifetime in the financial markets,” said Daniel Gross at Slate. Decisions that may get made now will have long-term consequences, and if Obama is going to end up being responsible for them, he might as well try to weigh in now, according to Gross:

It’s possible that further dramatic efforts won’t be necessary in the next 11 weeks simply because, with all the bailouts, there’s nobody left to fail. But plenty of other things could go wrong. We’ve given the Treasury secretary unprecedented powers to make life-or-death decisions about large financial institutions and to enter into financial arrangements that will last for several years. Given that Obama’s team will be dealing with the decisions Paulson made in August and that they’ll have to deal with the decisions Paulson makes in November and December, it’s imperative for them to get into the rooms where those decisions are being made — now. Think of it this way: If you’re slated to assume control of a mutual fund — say, one that has a concentrated portfolio in large financial companies — in January, and if you’re going to be held accountable for its performance, wouldn’t you want to sit in on the investment committee meetings right now?

David Leonhardt at The New York Times made the same point today:

This year’s election coincided with an important moment in the financial crisis. The credit markets have stabilized in the last few weeks and even improved a bit. But the rest of the economy is deteriorating fairly rapidly. It’s now in danger of falling into a vicious spiral, in which spending cuts by consumers and businesses lead to further layoffs and then more spending cuts.

To prevent that from happening, the Obama administration will need to move quickly — before it takes office — to put together some emergency plans for the financial markets and the broader economy.

Normally this time in a new presidency is filled with the sorts of things we’re seeing right now — recriminations on the losing side, and speculation about who will serve in the new administration. That’s why it’s so unusual to have a growing chorus of calls for Obama to take action on the economy before taking office.

It’s further evidence of the unprecedented nature of the credit crisis we’re in, and of the damage it threatens to do — even in just the next 11 weeks.

It’s an unlikely spot for a conservative White House that once lived and died railing against big-government interventionism. But these are lean times — and no town knows this better than Detroit.

Indeed, faced with free-falling sales, it appears likely that General Motors and Chrysler — two of Detroit’s struggling Big Three auto giants — will be merging, perhaps within days. The companies want Washington to pitch in billions to catalyze the deal — and administration officials are looking ever more likely to oblige.

It’s not quite how Adam Smith imagined things. By definition, businesses suffer in recessions. And true-market capitalism, at least in theory, exists only by the rules of financial Darwinism — the enduring concept that weak businesses must fail to make room for the strong.

Yet asked this week if including the automakers in Washington’s bailout plans encroaches too far on private markets, White House spokeswoman Dana Perino responded incomprehensibly:

Well, I think what I would point you back to is that decisions on whether or not — that these companies have in front of them as to how they will move forward and how they will deal with these changing market conditions and changing consumer preferences will be ones that they make. What we’re doing in the administration is working with the tools that Congress has provided us.

So when it comes to loans for retooling the factories and their floors so that they can produces more energy-efficient cars, we’re working within those means that Congress passed for us to be able to do that. And the same is true when it comes to the Troubled Asset Relief Program, where we’re looking at that.

The confusion, to an extent, is understandable. Mulling the best strategy for partial nationalization of the once-proud auto industry must be no easy position for a White House that sold itself to America as a champion of free-market conservatism. But Detroit CEOs have taken their plight directly to the Treasury, which Congress recently gifted with sweeping power to scoop up any troubled asset that threatens the nation’s economic stability.

Congress might have thought this bailout would be limited to Wall Street’s failing financial institutions. But, at this point, who would argue that Detroit’s automakers aren’t troubled assets as well?

The evidence, after all, is striking. GM’s domestic sales have fallen 18 percent this year, and Chrysler’s are down 25 percent. On Wednesday, news got bleaker when GM announced an 11.4 percent drop in global sales for the third quarter alone. The question remains whether Bush officials will deem these automakers, like Wall Street firms, too big to fail.

For some members of Congress, the answer is a no-brainer. In an Oct. 23 letter to the Treasury Sec. Henry Paulson Jr. and Federal Reserve Chairman Ben Bernanke, Michigan’s entire congressional delegation urged the administration to use its powers under the financial rescue bill to save the state’s famously regional industry.

Every segment of the U.S. automotive industry –- automobile manufacturers, dealers that are engaged in sales of autos and light-duty trucks, and auto finance companies that provide financing to dealers and to consumer and commercial purchasers of vehicles -– is experiencing devastating effects that have resulted from the worldwide crisis in financial and capital markets and the freeze-up in credit markets. … In this current economic environment it is imperative that the government ensures that liquidity is restored, so that the U.S. auto industry is able to function until normalcy is restored to credit markets.

Not everyone, though, agrees.

Steven Pearlstein, the Pulitzer Prize-winning business writer for The Washington Post, ran a piece Wednesday under the heading, “A Detroit Bankruptcy Beats a Bailout.” And an editorial in the Boston Globe Thursday points out that Detroit’s troubles go much deeper than the recent credit crisis. A historical over-reliance on gas-guzzling SUVs, for example, has disadvantaged America’s automakers as fuel costs have leapt in recent years. “A merger of GM and Chrysler would not fix these problems,” the Globe writes. “And federal backing for such a deal risks entrenching the status quo.”

Even Perino conceded this week that the failure of Detroit’s automakers is largely their own doing.

Complicating the saga, $25 billion in federal loans to help Detroit shift to more fuel-efficient vehicles could take between six and 18 months to arrive, the Bush administration announced earlier this month. To complete their merger deal, GM and Chrysler are requesting an early $10 billion from that allotment. They also want GMAC, their lending arm, to become a bank holding company, which would allow it to tap the $700-billion financial bailout program.

That merger could be finalized by Election Day, the Detroit Free Press reported Thursday.

Meanwhile, reporters might want to aim their questions about the administration’s bailout plans to someone other than Perino. Asked if any retailers offering lines of credit (Maytag was mentioned) would be eligible for bailout funding, the White House spokeswoman didn’t have the answer.

It’s a good question. It’s not one that I can answer, because I’m not part of the — I’m not an economist, that is a regulator looking at the Troubled Asset Relief Program. I don’t want to — I don’t think the White — I don’t think the White House would be open to that, but I just don’t know.

No wonder there’s so much confusion surrounding this program.

F-22 Raptors (Flickr: James Gordon)

The House Financial Services Committee, on Sept. 24, grilled Treasury Sec. Henry Paulson Jr. about the $700-billion financial bailout plan. The high-profile hearing signaled that lawmakers were not going to pass just any rescue bill before recessing to campaign.

But that same day, the House passed a bill almost as big — a $629-billion package titled the Consolidated Security Disaster Assistance and Continuing Appropriations Act of 2009. The legislation includes the Pentagon budget for next year.

The tab came to $488 billion — not including funding for the wars in Iraq and Afghanistan.

Illustration by: Matt Mahurin

Passing bills with little fanfare, including enormous defense budgets, is nothing new for Congress. But this defense appropriations bill is remarkable in a number of ways.

First, it never went through the appropriations committees in the House and Senate. Instead, the legislation was tacked on to the larger continuing appropriations bill a day before the House approved it. The bill is also remarkable because it increases funding for programs, like the F-22 fighter plane, that have been repeatedly criticized by Defense Sec. Robert Gates.

Gates and lawmakers from both parties have said Pentagon spending should be revamped. But that will likely have to wait at least another year.

“The legislative process was devoid of any reform,” said Winslow Wheeler, director of the Straus Military Reform Project at the Center for Defense Information, a non-partisan defense policy group. “To not even have a debate in the House or Senate was a cheapening of the process.”

Each year, Congress must pass 12 spending bills before Sept. 30 to keep the government running. As the Sept. 30 deadline approached, congressional leaders said they would only focus on the spending bills for the Dept. of Homeland Security, Veterans’ Affairs and the Pentagon.  Money for the other nine bills would be part of a continuing appropriations act that would keep spending at current levels until March 2009.

But only the Veterans’ Affairs bill was debated in either chamber. So as part of the continuing appropriations act, the House added on that VA bill and also a Dept. of Homeland Security spending bill introduced last year.

Rep. John Murtha (Flickr: Matthew Bradley)

As the continuing appropriations act was about to hit the House floor, the top-ranking heads of the the House defense appropriations subcommittee, Reps. John Murtha (D-Pa.) and Bill Young (R-Fla.), hashed out a defense-spending bill. The legislation was not debated and voted on by the full appropriations committee but went straight to the House floor.

The continuing appropriations act sailed through the House, 370-58. Three days later, it cleared the Senate, 78-12.

The bill then bypassed the usual next step of being the subject of a conference report between the House and Senate because Murtha and Young had already struck a compromise with their counterparts in the Senate, Sens. Daniel Inouye (D-Hawaii) and Ted Stevens (R-Alaska).

“I’ve never, ever seen a case where the entire defense spending bill was voted on and passed largely unseen by Congress and not at least go through a committee,” said Steve Ellis, a spokesman for Taxpayers for Common Sense. “It was made available to Congress at 11 p.m. Tuesday; and was voted on Wednesday afternoon the next day.”

In response, Matthew Mozankey, a Murtha spokesman, said in an email that, “Of course we would have liked to have gone through the process. But that wasn’t how it worked out.”

Mozankey disputed the idea that the bill was “done overnight,” noting that the appropriations subcommittee discussed it in August and also consulted with the Senate.

President George W. Bush signed the continuing appropriations act, which boosts defense spending by 6.2 percent, on Sept. 30. But more remarkable than the overall $488 billion price tag is the money the legislation channels to future combat systems, missile defense and the F-22.

Both Republicans and Democrats criticized these programs during congressional hearings, and the Government Accountability Office, Congress’ auditing arm, unfavorably evaluated them.

But their most prominent critic has been Gates, who reportedly may be in the next administration’s Cabinet.

Secretary of Defense Robert Gates (WDCpix)

In numerous speeches and testimony before Congress, Gates has criticized the Pentagon as having “next-war-itis”– focusing on hypothetical future enemies instead of the current asymmetrical, insurgent threats in Afghanistan and Iraq.

“In a world of finite knowledge and limited resources, where we have to make choices and set priorities,” Gates said in May at the conservative Heritage Foundation, “it makes sense to lean toward the most likely and lethal scenarios for our military. And it is hard to conceive of any country confronting the United States in conventional terms.”

In that speech, Gates specifically cited the costs and delays of future combat systems, an elaborate, oft-criticized plan to remake the Army through robotic and vehicle systems. But future combat systems got $26 million more in this year’s spending bill than the $3.6 billion requested by the Bush administration.

“Future Combat Systems marches on undisturbed,” said Wheeler, of the Center for Defense Information.

Perhaps no weapons systems has been as scrutinized aqs the F-22 fighter plane, first devised near the end of the Cold War to counter what some in the military saw as Soviet aircraft superiority. The first F-22, however, was not built until 2003, and Gates has questioned building more than the 183 planes already scheduled.

“We’re fighting two wars, in Iraq and Afghanistan,” Gates said at a February Senate Armed Services Committee hearing. “And the F-22 has not performed a single mission in either theater.”

But in this new bill the F-22 program got $523 million more than the $2.9 billion that the Bush administration wanted. “The subcommittee is looking at future threats,”  Mozonkey said in an email, “not only our ability to respond, but our ability to deter and prevent war.”

Murtha has also recently cited the conflict between Russia and Georgia as a reason to keep making weapons for the next war.

Mike Dunn, president and CEO of the nonprofit Air Force Assn., also evoked that conflict in defending the F-22. “If the president says, ‘set up a no-fly zone in Georgia,’ you need a F-22 to do that,” Dunn said.

But appeasing constituents with ties to the defense industry may have something to do with the F-22 spending increase. The plane is made by Lockheed Martin, as well as Pratt & Whitney, in Connecticut and Georgia. And Connecticut Rep. Rose DeLauro (D-Conn.) and two congressman from Georgia, Rep. Jim Marshall (D-Ga.) and Rep. Phil Gingrey (R-Ga.), were among the group of lawmakers that earmarked the extra F-22 money.

Funding for missile defense, another Cold War weapons system, dropped by about $200 million, from $8.9 billion $8.7 billion. But congressional earmarks for additional missile-defense projects totaled around $98 million. For example, Sen. Roger Wicker (R-Miss.) and Rep. Roy Blunt (D-Mo.) got $28 million for a short-range ballistic missile defense program called “David’s sling.”

The spending increases come as major defense contractors brace for cuts.  Last week, Boeing CEO Jim McNerny wrote to employees that there will be “some measure of impact” from the bailout of the financial system on weapons procurement.

On the other hand, advocates for greater defense spending point out that what they asked for — and Congress and the president have provided — no longer seems as expensive when compared to the cost of bailing out the financial system.

“The government spent $1.3 trillion on Fannie [Mae], Freddie [Mac], a stimulus package that didn’t work and a big bailout,” said Dunn. “We’re just asking for a few billion to replace airplanes.”

Flickr: entobox

Three sound-bites led to the passage of the biggest bailout in world history. The first was that the bailout is “not just for the fat cats” on Wall Street. This, in turn, is because in this crisis “Wall Street and Main Street are joined at the hip.” Finally, anybody who challenges this is told that he/she “just doesn’t get it.” The bottom line is that if taxpayers did not acquiesce and support the trillion-dollar-plus rescue plan, and the bill failed to pass, really bad things would happen to Main Street.

Isn’t it odd that Wall Street and Main Street are never joined at the hip when Main Street is foundering? In such times “market discipline” and moral hazard are the watchwords. But the moment Wall Street firms’ balance sheets begin to falter, the relationship between Wall Street and Main Street magically transforms itself from parasitic to symbiotic.

Illustration by: Matt Mahurin

A careful look at the $700-billion Troubled Assets Relief Program, or TARP, suggests the interests of Wall Street and Main Street are really not aligned in this bill. It seems clear that the bailout plan will do little to help Main Street. Any benefits will be marginal and indirect. On the other hand, TARP will help Wall Street firms — and it will help it a lot.

Toxic derivatives, particularly collateralized debt obligations, or CDOs, and credit default swaps dominate the balance sheets of Wall Street firms. Most regional and community banks’ balance sheets are largely free of these troubled mortgage assets. Thus bailout won’t do any good for these Main Street banks. It will just help their far riskier, far bigger Wall Street rivals.

The core feature of TARP is that it gives the Treasury Dept. hundreds of billions of dollars in U.S. taxpayer funds to buy bad mortgage assets from the (mainly) Wall Street firms that bet on these highly risky, and now deeply troubled, assets. But, of course, the statute does not require Wall Street firms to sell assets to the government. They only agree to sell them if the price is right.

This means that if the Treasury is actually going to buy any assets, as it surely will, the price paid for these assets inevitably will be above both the market value and the book value of these assets — otherwise no bank would unload them.

It is easy to explain why. If the price offered by the Treasury is not above market value, then no bank would sell to the Treasury: it would sell the asset into the market at the higher market price instead. If the price the Treasury is willing to pay is not above the value recorded for that asset on the selling bank’s books, then the bank is better off holding onto the asset — since selling would force the bank to recognize a loss and cause an immediate reduction in the bank’s capital equal to the difference between the book value and the (lower) price paid by the Treasury.

Imagine, as is probably the case, that whoever acquires Wachovia acquires a large number of questionable “pick- a-pay” mortgages that have a real economic value of only $10 billion, but were once considered to be worth $20 billion. Pick-a-pay mortgages, otherwise known as negative amortization loans, feature a low minimum payment — usually 1 percent — and give the borrower the option to make interest-only payments, at least for a while.

Borrowers with such loans usually make only the trivial minimum payment due each month rather than the actual interest rate. This serves only to delay the time when the borrower must pay the actual interest owed.

The unpaid interest quickly accumulates. When the amount of principal and deferred interest hits, say, 110 percent of the original loan balance. the minimum payment option disappears, and the loan resets with a new minimum payment that will be substantially higher.

Under TARP, U.S. taxpayers or, according to Wall Street, the Treasury Dept. would pay, say $15 billion for these mortgages at Wachovia. This would mean a gain of $5 billion. It would go directly to the bottom line — i.e. to the shareholders of Wells Fargo or Citigroup or whoever buys Wachovia.

The acquirer will immediately be financially stronger, show improved earnings and have $15 billion in new cash before taxes. No wonder Wachovia suddenly looks like such a fantastic target.

To sweeten the pot even more, the Treasury has thrown in some additional tax breaks. Specifically, new interest in Wachovia may have been sparked by an IRS notice issued last Tuesday that increases the tax deductions that can be taken by acquirers to off-set Wachovia’s loan losses.

The notice would remove the current strict limits on the deductions an acquirer could make for the loan losses and bad debt deductions that Wachovia sustains following the acquisition. Some experts have estimated that for certain borrowers, including Wells Fargo, the entire cost of acquiring Wachovia could be offset with the tax savings from this rule change.

The $700-billion dollar question is what Citigroup, Morgan Stanley and the other Wall Street firms who get cash in the bailout will do with the money they get for selling toxic mortgage-backed securities to the Treasury. It is by no means certain that the firms will use their new-found hundreds of billions to make new mortgage loans or otherwise plow the money back into Main Street.

After taking huge losses on their portfolios, these Wall Street firms are likely to be far more restrictive in their future lending practices. As taxpayers funding the bailout, we are delighted by the banks’ newly found risk-aversion. Borrowers on Main Street will not benefit from the cash hoarding that is the newest Wall Street fad.

Regardless of what Wall Street firms do with the money they receive, it goes directly to the bottom line of the Wall Street firms. Main Street has to take it on blind faith that Wall Street will share some of the Treasury’s largess with them. Wall Street is known for a lot of things — sharing is not one of them.

It is highly doubtful, then, that much, if any, of this money will actually trickle down to Main Street. Even in the highly unlikely event that the Treasury plan jump-starts a nascent market for the toxic paper held by Wall Street, there is no reason to believe that the money generated by this new market will find its way from Wall Street to Main Street.

Bonus time is approaching on Wall Street. Inevitably, some, if not most of the $700-billion early Christmas gift from Nancy Pelosi and Hank Paulson Jr. will find its way into the pockets of investment bankers, saving Wall Street, but not Main Street, from one of its worst years in history.

Jim Holdcroft is a partner in the private-equity firm, Landmark Partners. Jonathan Macey is the Sam Harris Professor of Corporate Law, Corporate Finance & Securities Law at Yale Law School and author of a new book “Corporate Governance: Promises Made, Promises Broken.”

UPDATE: Jonathan Macey appeared on the ABC News show 20/20 on Friday night and had this to say about the economic crisis:

Bush went first, explaining to the American people that Washington will invest $250 billion in the nation’s banks. The Treasury Dept. will take equity stakes in banks, which have been pressed into accepting partial nationalization in return for an investment of taxpayer money. The FDIC is set to talk about launching an insurance fund to guarantee new issues of bank debt.

Bush defended the move, saying it’s not an abandonment of the free market.

Angry Bear puts it this way:

I’ve always wanted to have my very own bank…

The Big Picture has a rundown of which banks will get the money – and how much they’ll get. And a little commentary on the fact that, as unthinkable as partially nationalizing banks may seem, it should have happened far sooner:

Federal Reserve Chairman Ben Bernanke (WDCpix)

Amid the clamor over the crisis on Wall Street, the U.S. Treasury’s $700 billion Troubled Asset Rescue Program, or “TARP,” bill and the evolving collapse of the global banking system, little attention has been paid to the extraordinary credit extensions at the Federal Reserve. But these are now without parallel in Fed history, including during the Great Depression.

In the last three weeks, Federal Reserve Chairman Ben S. Bernanke, with the help of Treasury Sec. Henry Paulson Jr., has increased the Fed’s credit extensions by $650 billion — roughly the same amount as the TARP. Taken together with the Fannie Mae/Freddie Mac bailouts, new Fed credits in just the last month or so now amount to some $1.6 trillion. Here’s how they did it.

Illustration by: Matt Mahurin

The Fed, to begin with, is a bank. Like other banks, it makes loans and investments, which are its “assets.” It finances them by taking deposits, mostly from its member banks, and raising capital, its “liabilities.” In the normal case, almost all its assets are loans to the government, or Treasury bills, notes and bonds; while its primary liabilities are its own debt certificates.

You’ve seen the Fed’s debt certificates; they’re green and carry the legend “Federal Reserve Note.” In other words, money. The Fed’s role in the economy is to stabilize the money supply so it is neither too plentiful, which can generate inflation, nor too scarce. It does so largely by manipulating the rate of interest that banks charge each other for overnight loans, the “Fed Funds” rate. If the Fed issues more currency to buy Treasuries from its member banks, banks become more liquid and the Fed Funds rate should fall; and vice-versa.

Bernanke is a serious academic who devoted much of his career to extensive studies of the failure of central banks during the Great Depression. He is the lead author of a 2004 Federal Reserve working paper, exploring the Fed’s policy alternatives “At the Zero Bound” — or the point where the usual tools of interest-rate policy cease to have any effect on the real economy.

In the paper, Bernanke poses a common policy conundrum. It sometimes happens that pushing down Fed Funds rates has no effect on medium- or long-term rates — or can even make them rise, if markets are worried that too much liquidity could cause inflation.

In such a case, Bernanke suggests, the Fed could use its balance sheet in a more targeted way. “If the Federal Reserve were willing to purchase an unlimited amount of a particular asset, say, a Treasury security, at a fixed price,” Bernanke wrote, “there is little doubt that it could establish that asset’s price.” But the Princeton economics professor also warned that the Fed should be “cautious” about such a strategy, since its results could be “quite uncertain.”

Starting in late 2007, and continuing ever more aggressively through 2008, Bernanke, as chairman, started precisely such an experiment in using the Fed’s purchasing power to target asset prices. But instead of targeting specific maturities of Treasuries, he targeted the illiquid assets weighing down bank balance sheets. In effect, could the Fed establish the price of the complex subprime mortgage-backed debt instruments, known as “CDOs’:and similar paper that has been destroying bank balance sheets?

The first attempt, in December, 2007, was appropriately cautious — it was relatively small and short-term; open only to Federal Reserve system member banks, and circumspect on acceptable securities. But step-by-step, he expanded the eligible borrowers from member banks to broker-dealers, then to AIG, an insurance company, and, most recently, directly to major corporations, mostly on an unsecured basis. At the same time, Bernanke greatly increased the volume and the range of targeted securities he would lend against, to include “investment-grade” (translation: “anything not junk”) CDOs.

The Fed’s weekly balance sheet has evolved into a fever-chart of Bernanke’s interventions. Start with the balance sheet of a year ago, in October, 2007. Total Fed assets were $890 billion, of which $780 billion comprised Treasuries, with the balance scattered among gold certificates, physical plant and other miscellany — or roughly the size it had been for several years.

Now jump ahead to the balance sheet from last week. The Fed’s assets have swelled to $1.6 trillion, an increase of 80 percent. But only $265 billion are Treasuries actually held at the Fed. The rest are a mélange of god-knows-what instruments vacuumed up from banks and investment banks.

There are $149 billion in dicey securities exchanged for Treasuries in bi-weekly auctions; “Other Loans,” to the tune of $420 billion (all we know is that it includes the credit extension to AIG, which has climbed to about $100 billion); a special $29-billion line for Bear Stearns, and $145 billion in direct lending to companies. There is also $325 billion in “Other Assets” — probably mostly dollars for foreign central banks to help local banks choking on dollar-based CDOs and other poison apples from America.

The total lending expansion, therefore, was about $700 billion, with about $650 billion in just three weeks since Paulson and Bernanke proposed what became TARP to purchase banks’ bad assets, or otherwise provide them with new equity.

In other words, even as academics and Congress agonized over TARP, Bernanke and Paulson had already pumped out roughly that amount of money — without so much as asking for a by-your-leave. Paulson even engineered a special $400-billion Treasury borrowing program -– i.e., increased the federal debt — to supply part of the extra cash needed to support Bernanke’s lending.

Fascinatingly, Bernanke’s fire-hose of liquidity has so far been accompanied by a steady tightening of lending conditions. Some market watchers worry that interbank liquidity is drying up because borrowing at the Fed is so much easier. Only time will tell.

If there’s one lesson from the past few years, it is the formidable nature of the law of unintended consequences. The vast new infusions of dollars will weigh on U.S. international balances for years. It is all in the name of staving off a “recession,” which now looks something like the 1960s specter of nuclear Armageddon.

We may have reached the point where the cure is scarier than the disease.

Charles R. Morris, a lawyer and former banker, is the author of “The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash.” His other books include “The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy” and “Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

New money, as in, additional to the $700 billion already appropriated by Congress to bailout failing Wall Street firms.

From ABC:

Asked if his mortgage plan would be “new money or part of the $700 billion” already appropriated by Congress for the Wall Street bailout, McCain said, “part of the $700 billion, new money, if necessary.”

“Look,” he continued, “in one day they wiped out $1.2 trillion when it dropped 700 points. And I’m not throwing this money around lightly. But if the housing values continue to go down, there’s no floor. There’s no turnaround here. We all know what was the catalyst for this catastrophe. And that was Fannie and Freddie.”

McCain’s plan, announced Tuesday at the presidential debate in Nashville, has come under criticism for putting taxpayers on the hook for bad loans made by banks.

However, The Atlantic’s Marc Ambinder raises the possibility that the plan may already be illegal:

Folks who are much more savvy on the specifics of the Troubled Asset Relief Program (TARP) wonder whether the government’s $700 billion bailout/rescue program expressly prohibits what John McCain now says he wants to do — and that is to have the government buy distressed mortgages at face value from banks and renegotiate their terms with homeowners.

They point me to Section 101e of the law, which requires the Secretary of the Treasury to “take such steps as may be necessary to prevent unjust enrichment of financial institutions participating in a program established under this section”

Here’s the key part…

… “including by preventing the sale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset.” Any loan that is not held by the originator, and the vast majority loans are not, would fall under this provision.”

So — if the bank gave you a 100 dollar loan…. and sold it for 80 bucks last year, and it’s trading at 50 dollars now, the law prohibits the government from buying it at $100 — face value — because that would “unjustly enrich” the entity which purchased the mortgage from the bank.

Under TARP, the government wouldn’t be able to buy it for more than $80… which isn’t face value.

So if they buy it at face value, wouldn’t they violate the law?

If this is the case, it could be back to the economic drawing board for McCain. It’s no secret the financial crisis is killing him in the polls.

If the “William Ayers”-strategy of diverting attention from the nation’s economic woes turns out to be the non-starter that it appears to be, McCain has 25 days and counting to start connecting with voters on the issues that really matter to them — like remaining their homes and being able to retire.

If he can’t do that, he can probably kiss the presidency good-bye.