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Firms Preen for Government Beauty Contest
Asset Backed Alert, Harrison Scott Publications Inc. (September 26, 2008)

The field of companies pursuing work associated with the federal government's $700 billion plan to cleanse financial institutions of devalued mortgage assets is growing rapidly.

Among the players positioning themselves to win assignments is Pentalpha, a Greenwich, Conn., firm that specializes in analyzing and managing pools of troubled home loans. It joins a host of bigger shops that were already jockeying for assignments to guide the government on purchases and management of debt - including BlackRock, BlackStone, J.P. Morgan, Morgan Stanley and Pimco.

Meanwhile, law firms Katten Muchin and McKee Nelson are laying the groundwork to serve as advisors to the managers the government ultimately hires. For example, Katten set up a task force this week that would aid those shops in figuring out what to do with the distressed assets they end up overseeing. The group is led by Hays Ellisen and Eric Adams, both of whom are partners in the firm's securitization practice.

Even more companies are planning to throw their hats in the ring in the coming days. The early interest in finding ways to profit from the planned financial-system bailout contrasts with uncertainty that surrounds how the process would work. For instance, it still isn't clear which assignments would be up for grabs, exactly what they would entail, or how to apply.

What's more, the nature of any government contracts could be swayed by developments in the plan, which represents the boldest attempt so far by U.S. Treasury Secretary Henry Paulson to combat the ongoing credit crisis. Regardless of the outcome, a Treasury spokeswoman noted that any application process would be public. Industry players aren't convinced that will be the case, however.

Some are still wondering how BlackRock won a role in the Federal Reserve-backed takeover of Bear Stearns by J.P. Morgan in February. That arrangement landed New York-based BlackRock an assignment to manage a $30 billion pool of distressed mortgage assets that the Fed took on from Bear as collateral for a loan to J.P. Morgan.

The resulting sentiment among market insiders is that any hiring of managers or advisors could take place suddenly and without a standard request-for-proposals process. That, in turn, is contributing to what is already a heated sense of competition among potential contractors. Many candidates are concentrating their efforts on cozying up to government officials who might be able to help them win assignments, while others prepare proposals that explain why they consider themselves best situated for the jobs - including some shops that might also be direct beneficiaries of above-market asset purchases.

Still, there are a lot of moving parts. Giving prospective managers a hint of what they might contend with are proposals drafted separately this week by Rep. Barney Frank (D-Mass.) and Sen. Chris Dodd (D-Conn). If Frank's proposal gains traction, the FDIC will likely play a role in managing mortgages that would be among the assets the government buys. His version says the FDIC "shall be eligible and shall be considered in the selection of asset-managers for whole loans and shall be reimbursed by the [Treasury] Secretary for any services provided."

The agency might have a hard time staffing up for such an effort. Right now, its workforce is riddled with vacancies, including 85 open slots for "financial institution specialists" across the country. Expected failures by regional banks saddled with troubled debt are also expected to keep FDIC employees busier than usual in the coming months.

Among private-sector shops, Pentalpha co-founder James Callahan argues that managers with expertise in loans will be better equipped to work with the government than bond specialists. "The problem is we have loan problems, not bond problems," he said. "There are two issues: How do you buy out this stuff, and how do you get the markets to start it up again?"

Another wild card is what types of assets the government fund will scoop up. While mortgages and related structured products are at the heart of the credit crunch, there has been a push to expand the initiative to other types of distressed debt, which would probably play a role in determining which shops land assignments.

Then there's the question of what the selected companies do with the assets once they have purchased them. "You don't want to sell them," at least not right away, Katten Muchin's Ellisen said.

One idea is that the government might issue covered bonds backed by some of the investments, which it would then guarantee. That move might help jump start a market for covered bonds, which federal officials have endorsed in the past. However, the government would first have to loosen standards for collateral it allows to underpin such issues. Regulation remains a moving target as well. Paulson's version of the plan would prohibit any legal or administrative review of his office's decisions with respect to the program. But that's not likely to fly with Congress. The proposals from Frank and Dodd, for instance, call for regular reports - along with standardized processes to select contractors and consideration of potential conflicts of interest.

What's more, restrictions on executive compensation suggested by Frank would cover money managers hired by the government. Those firms' leaders would have to give back bonuses based on overstated earnings. They also wouldn't be eligible for severance pay while commissioned by the government, nor would they receive bonuses for overly risky moves. Dodd's bill includes a similar executive-compensation section. v



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