So after telling firms that if they agree to participate in its program establishing a public-private partnership to buy toxic assets (PPIP) they would not interfere with the internal affairs of the banks, the Treasury now is saying that it may be subject to executive-compensation caps after all.

The Washington Post reports:

Treasury Department lawyers have determined that firms participating in a $1 trillion program to relieve banks of toxic assets could be subject to limits on executive compensation, contradicting the Obama administration’s previous public position, according to a report to be released today by a federal watchdog agency. . . .
Speaking last month about the initiative to buy toxic assets, Treasury Secretary Timothy F. Geithner said, “The comp conditions will not apply to the asset managers and investors in the program.”
But Treasury lawyers have told the special inspector general for the federal bailout that executives involved with that initiative and another $1 trillion consumer lending program “could be subject to the executive compensation restrictions,” according to the report from Special Inspector General Neil M. Barofsky.”

The Economist is not surprised by this flip-flopping:

But is it really that surprising? Banks were pressured to take TARP money last fall and were quickly dismayed when the government started calling the shots on pay and making it harder to hire foreign labour. Now they can’t give the money back.

Over at the Atlantic.com, Megan McArdle nicely summarizes the potential effects of this news:

Clearly, if there are pay caps on the investors, PPIP is dead. And even if there aren’t, I’d say the likelihood that a given firm will participate has just declined substantially. There is clearly enormous regulatory risk for anyone who chooses to get involved with any of these programs.