In the waning days of December, U.S. Treasury Secretary Henry Paulson ensconced himself in a smoke-filled back room (well, presumably that’s where it was; that’s where shady deals are so often made) with the heads of several large banks, including Citigroup, Wells Fargo and Washington Mutual. Also present were the heads of the FDIC, the OCC and the OTS. They met to forge a plan to bail out subprime ARM borrowers facing looming resets.

Before dissecting Paulson’s plan, let’s get some important facts on the table. First, 1.5 million to 2 million ARMs worth about $540 billion will reset in 2008. Of that, about 80 percent is subprime or alt-A paper. And second, the market values of the three banks mentioned above were down 42 percent, 14 percent, and 60 percent on the year, respectively, the day before the meeting. That’s a key factor in their participation.

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