Financial markets head into the weekend with no deal on U.S. Treasury Secretary Henry Paulson’s plan to get credit markets moving with a massive buyout of illiquid mortgage securities. Analysts are still hopeful, but cautious in predicting a deal will be reached.

The weekend will see ongoing talks in Congress, with the hope that a deal is reached before markets open on Monday. Global Insight Inc. notes that the administration and Congress made considerable progress through Thursday in developing more refined legislation on the Troubled Asset Repurchase Plan. “The plan was further elaborated to include a phased-in approach, foreclosure prevention, limits on executive compensation, elements of equity participation, and oversight,” it reports.

“However, a group in Congress is hastily attempting to craft a competing plan whereby banks would be able to purchase insurance for mortgage-based assets. This competing plan has very few details, so it is difficult to say at this point whether or not it has any merit,” it says. “However, the delay in moving forward on the modified TARP plan is creating a considerable amount of uncertainty in the markets—raising concerns about where leadership is moving on managing the financial crisis.”

The main stumbling block with the plan is the manner is which it is being presented to the public, Global Insight suggests. It argues that this is not a US$700-billion bailout. “The banking system overall will still have to bear some additional costs related to the mortgage assets crisis even if the TARP plan is approved—so the key question is, how much more cost in the form of asset write-downs can the financial system withstand without folding in on itself?” it says.

CIBC World Markets Inc. points out that the problem is that the plan, even the modified plan designed to punish banks a bit more, has “no voter appeal.

“If it’s approved, the electorate never gets to see how the economy would have fared without it, and it will take a long time to see what, if any, the cost to taxpayers will be,” it says. “But if nothing is done, all parties would face the wrath of the public during the resulting deterioration in economic and financial market conditions. As a result, we still put better odds of a deal emerging than not.”

BMO Capital Markets’ chief economist Sherry Cooper observes that, “The public would rather the government use some of the US$700 billion to help individuals keep their homes.

“This would be difficult to administer, requiring many transactions all over the country,” she notes. “But the government could assist all [eligible] homeowners through low-cost mortgage refinancing [up to some dollar limit] at something like the discount rate [now 2.25%], reducing taxpayer risk by eliminating the no-recourse feature of current mortgages—meaning that the government could tap other household assets beyond the home if the loan goes into default.

“Recapitalizing the banks could be done more efficiently through government injection of preferred equity, letting the market determine the value of mortgage securities. Can the government value these complex securities using taxpayer money better than private market participants betting their own money?” she adds.

“In all likelihood a deal of some form or another will be reached, though trying to bet on its final form is perhaps just slightly less risky than certain types of asset-backed securities,” says TD Economics. Still, it adds that, “Actions of policymakers are necessary but will not likely be sufficient to put an immediate end to the credit crisis. Friday’s failure of Washington Mutual illustrates what is the fundamental problem in the banking industry – lack of capital. Even if a deal is reached, the process of deleveraging and raising capital will continue to hamper the U.S. and global economies for the next several quarters.”

If no deal is reached, CIBC says that in the near term, there would be downside for equities, cyclical commodities, commodity-linked currencies and financial sector bonds, and upside for government bonds. “The Fed would, at a minimum, have to upscale its support in the money market to prevent floating-rate yields from soaring, even if it decides to stay with a 2% funds rate.”

“Until credit spreads begin to narrow on a sustainable basis, all risky asset classes will remain under downward pressure,” adds BCA Research. “Good news is needed out of Washington, and soon.”

@page_break@Global Insight insists that the modified TARP program is a “reasonable compromise.” It concludes, “It goes without saying that more work needs to be done on the fine print of the program. But we cannot see how any major distraction from this exercise would lower prospective costs to the taxpayer or be constructive at this stage of the crisis.”