Barney Frank, the Democrat chairman of the House of Representatives Financial Services Committee, is giving Hank Paulson and Ben Bernanke a torrid time over the Paulson bail-out plan and using the debate to grandstand over executive pay on Wall Street, which seems fair enough. In fact both presidential candidates have joined in that bit.

Frank is pushing to include limits on executive compensation in those firms that offload assets to the Treasury. Christopher Dodd, chairman of Senate Banking Committee, wants a five-member supervisory board to oversee the purchases. John McCain also wants an oversight board; his would include Warren Buffett and Michael Bloomberg.

That’s the problem with putting up a plan like this during an election campaign: everyone wants to put in their two-cents worth, and there is almost no chance of it getting up in an uncomplicated and useful way.

Whether or not it’s a good plan, at least it’s a plan and it’s the only one they’ve got at the moment. Paul Krugman in the New York Times calls it a “slap in the face” policy — that is, markets are getting hysterical and need to be calmed down with a slap in the face.

The idea is that Treasury’s slap would set a new level of value in the mortgage backed securities market. Obviously $US700 billion is not enough to buy all of the MBS held by banks, but it would raise the general level of prices.

The problem with the Barney Frank-led campaign to change it is that the purchases are not mandatory. The Treasury would simply offer to buy up to $US700 billion in mortgage backed securities at “hold to maturity” valuations, as opposed to distressed market values.

The reason there were no strings attached is that in order to work, banks and other financiers must want to use it. If it’s too complicated, or too punitive, they won’t.

And in the meantime, while they argue about it, bank runs are breaking out (yesterday there was a run on Bank of East Asia in Hong Kong). Runs are liquidity events, of course, not solvency or valuation events, so while the Paulson Plan would help with the fundamentals of valuation and confidence, once a run is underway it would make no difference.

The question remains whether it is necessary, or even a good idea. Solvent banks should not be recapitalised by the government because they are unwilling to meet the market price for capital at the moment. Insolvent banks need to have their depositors protected by depositor insurance and their shareholders wiped out.

As discussed here yesterday, all of the financial distress at present is caused by the collapse of the housing bubble. The correction is necessary and the market has to be cleared, but it is not painless. Some people who made a lot of money during the bubble will now lose a lot. Some of the outcomes won’t be fair — some Wall Street bankers will retire to their yachts with billions, other investors who came in late will lose everything.

But the fact is that there is enough money available to buy the distressed assets as long as the price is right. What is essentially happening now is a sort of mass negotiation between the distressed sellers who got caught with housing bubble assets, and the potential buyers who are standing back waiting for prices to reach bottom.

In that context, Warren Buffett’s decision yesterday to put $US5 billion into Goldman Sachs was an important signal (Buffett shifts from fear to greed, September 24).

The Paulson Plan is an attempt to influence that negotiation by setting a floor price on MBS, but it is getting mangled in the US election mincer. It might get up, and it might work, but maybe not, and in the meantime the financial world is on a knife-edge and more bank runs are likely.

Longer term, the banking model will change so that banks become much more like utilities – gearing and liquidity will need to be significantly more conservative than previously.

The days of 20 per cent plus returns from running 20 times gearing, running virtually no cash reserves and manufacturing liquidity by trading derivatives are over.

In the short term a housing bust needs to be cleared.