The $700b bailout

With $40b spent on AIG stock, half of funds are accounted for. Who will get what is left?

WASHINGTON - The ingredients: an economy in peril, a lame-duck Congress and president, a president-elect in transition, and a $700 billion pile of bailout money available to those in greatest need.

The result: The available bailout money is shrinking even faster than anticipated, and it's already being spent in ways not previously anticipated. Yesterday, the Bush administration decided to use $40 billion from the bailout funds to buy stock in the struggling insurance company American International Group Inc., while automakers teetering on the brink urged that they be added to the list of those allowed to tap the funds.

President-elect Barack Obama, meanwhile, was not asked whether he approved of the decision to invest an additional $40 billion in AIG, an administration official said. Obama is waiting in the wings, hoping there is enough bailout money left for him to put his imprint on the program by the time he takes office Jan. 20. Already, his aides have said they want to help automakers, but they have not provided specifics.

Indeed, with many homeowners facing foreclosure and some businesses near bankruptcy, there are countless ways to spend the money "if you add up all the companies in the country that are in trouble," said Peter Morici, a University of Maryland School of Business professor who is closely monitoring the expenditure of bailout funds. But unless systemic changes are made in the companies that get the money, he said, it might not go far in turning around the economy. For example, Morici questioned whether the auto industry can recover without a new labor agreement and a way to cut more of its healthcare costs.

Last week, House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid wrote to the Bush administration asking whether automakers could be included in the $700 billion package. Although Congress separately approved a $25 billion loan to the industry, the auto companies have said they need more money and have looked to the bailout program as a potential source.

But Massachusetts Democrat Barney Frank, chairman of the House Financial Services Committee, said in an interview yesterday he opposes using any of the $700 billion for the auto industry. The bailout money is needed to free up credit, said Frank, who stressed he would not be opposed to finding other ways to help the auto industry.

"I do think there should be aid to automakers, but not as part of this program," he said.

Under the bailout bill, President Bush was given the authority to spend the first $350 billion as he sees fit, with another $350 billion contingent on whether lawmakers are satisfied with how the program is working. Frank said he will hold hearings next week in an effort to determine whether banks are lending as much money as they receive from the government.

Of the $350 billion allocated so far, $250 billion is to be used to recapitalize financial institutions, $40 billion is for AIG, and the remaining $60 billion is available for other uses. While automakers and other troubled industries might try to stake a claim to the $60 billion, Frank said it should be used largely to buy up troubled mortgage-backed assets and other bad debts. But while the purchase of bad mortgage-backed assets was at the center of the debate over the bailout, none of those assets have been purchased so far, a Treasury spokeswoman said yesterday.

A separately funded program to help homeowners who face foreclosure, Hope for Homeowners, has been underway for less than six weeks, too little time to determine its effectiveness, according to government officials.

The decision by the Bush administration to provide more money to AIG underscored the difficulty of predicting how the bailout money will be spent. Administration officials said the precariousness of AIG's financial condition in September was underestimated. The government had hoped federal loans and a credit line worth $123 billion would save the massive insurer. The administration now says AIG, deemed too vital to the economy to be allowed to fail, needs $150 billion and more time to repay its debt. As a result, the government eased the terms of the previous loan and used $40 billion of bailout funds to buy preferred stock in the company.

The government's decision to become a major investor in AIG is bound to raise questions about whether it should similarly invest in auto companies and other businesses suffering massive losses. Louis Lataif, former president of Ford Motor Co.'s European operations and now dean of Boston University's School of Management, said the government should consider loaning money to automakers to help them get through the next two years. Without such a loan, Lataif said, it is possible that General Motors Corp. or another large carmaker could collapse, sending damaging reverberations throughout an already weakened economy. Still, he opposes using public money to buy outright stakes in the firms.

The Bush administration did not consult Obama or congressional leaders in deciding to spend the $40 billion on AIG. Frank, who was briefed on the plan Sunday night, said he hoped the White House would work more closely with the Obama transition team on expenditures it wants to make before the presidency changes hands.

As for the second installment of $350 billion, it is not yet clear whether that will be allocated before or after Obama becomes president. Either way, officials said it is likely Obama will be able to control how most of the money is spent.

Michael Kranish can be reached at kranish@globe.com.