Here is the full text of the Paulson/Treasury plan as sent to congress late yesterday. It is deliberately vague, of course, which will makes its Congressional ride a roller-coaster. At least as importantly, the two key numbers: $700-billion and $3-trillion. The former is the amount that Paulson would like authorized for securities purchases, and the latter is the amount by which Paulson would like to "temporarily" increase the U.S. debt limit.

LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY TO PURCHASE MORTGAGE-RELATED ASSETS

Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.--The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

(b) Necessary Actions.--The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for--

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.--The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.--The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.--The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.- -The authority of the Secretary to hold any mortgage- related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary's authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.--The term mortgage- related assets means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

(2) Secretary.--The term Secretary means the Secretary of the Treasury.

(3) United States.--The term United States means the States, territories, and possessions of the United States and the District of Columbia.

While no-one is likely to change their mind on this -- the vilification of short-sellers is more or less complete -- but let's keep working away at it. Here is some data on the role of short-sellers in Morgan Stanley's decline this week, specifically the presence that short-sellers had in Morgan Stanley stock. The numbers reflect the percentage of MS's market value sold short at the time in question (according to Data Explorers):

July 2008: 7% (peak)

Sept. 1, 2008: 2%

Sept. 16, 2008: 2.8%

Are these numbers non-zero? Yes. Are they monstrously large, as conspiracy theorists are alleging? No. Are they large in historical terms? No. And had we hit new peaks in recent weeks? No.

Next question.

I was scanning some Morgan Stanley bond data this morning, specifically its 6.625% issue maturing in 2018. Its recent behavior is instructive in thinking about what happened last week, how unusual it was in historical terms, and why models broke down as badly as they did.

Morgan Stanley is seen as a stable issuer, and this bond has traded accordingly. It has sat more or less flat between $94 and $96 over the last three months, hardly moving at all through the various waves of the credit crisis.

And then last week struck. In the space of two days the bond price fell from $94 to as low as $60, only to recover again to $84 by yesterday afternoon.

Think about what what means in statistical terms. The mean price for this bond most of the early part of this year was around $94, and the standard deviation on a daily basis was approximately $0.45. Assuming normality (which is a species of the assumption made my many default risk modelers), and noticing that we saw a $34 price decline, we witnessed a 50-plus standard deviation event, the sort of thing that shouldn't happen without dinosaurs reappearing too.

In short, to a first approximation, at least from a modeling point of view, last week didn't happen. And hence the problem with frequentist risk models, which is, in part, why we are in the trouble we are in. These models work wonderfully, until something exogenous changes, and then they don't work at all anymore.