And it's not just the 5% "coupon" (dividend, technically), that marks this as bad relative to the Buffet deal. Buffet received an equivalent amount ($5 billion) of favorably-priced common stock warrants that he can exercise anytime during the next five years. The rough plan for Paulson, as I understand it, is for the Treasury to get warrants equal to just 15% of the preferred stock injection.

Also striking is how different this is than the Treasury-AIG deal. I understand that the AIG bailout was for different purposes -- AIG was going immediately bankrupt whereas the solvency of the banking system over the next, say, 24 hours, is relatively assured (with diminishing levels of confidence the farther one goes out) -- but the Treasury charged AIG for its loan facility a rate of LIBOR + 8.5%. While I understand that there is a difference between a loan and a preferred stock purchase, they are not all that different: preferred stock is like a bond, but with fewer recovery protections, and like a stock for capitalization purposes, but it doesn't share in the broader common stock market gains. The important point with the present Paulson action is, to my eye, that the Treasury picked a very low fixed rate for a LONG time (five years!) without reference to LIBOR.

It's not crazy to assume that interest rates will go up within the next five years. It's also not crazy to assume that there will be few buyers -- probably not $250 billion worth -- in the near future for Treasury's preferred stock for anything under 100-200 bps + LIBOR. So if Treasury wants to unload the preferred shares once the market stabilizes, how do we get out of the position? If the market is going to demand a reasonable rate of return on this asset, then the price of our investment will drop until the interest rate is at the market yield. Even if Treasury sweetens the deal for some buyer by waiving cap gains taxes or whatever, it's still money lost from the fisc. (It's unclear to me whether the Treasury has commitments from the banks to buy out the government stakes for par value.)

The worst part, perhaps, is that the British avoided this almost entirely, taking huge stakes in common stock (with some preferred shares). The NYT and WSJ reported that the big three UK banks saw their stock price fall after the deal was announced because of the dilutive effect of those transactions; to which I say -- isn't that a reflection of the moral hazard inherent in the risks those banks and shareholders took to bring them to this position? What would be irresponsible is to allow the system to fail. What is responsible is to save the system without unduly rewarding risk-taking that has produced failure.

But Paulson manages to do just that. The way that Paulson, even when doing an ostensibly better thing by the taxpayers than he previously proposed, manages to slant a good act in the worst possible way is just stunning.