Consequently, it’s rare today to see someone rise to national government from the farm. So even though Paulson has a fancy big city MBA from Harvard Business School and a personal fortune in the hundreds of millions from a sterling stint at the helm of Goldman Sachs (GS), we expect him to plainly possess the honesty, industriousness, and salt of the earth common sense that we romantically assign to farmers. Goldman by the way received a huge investment from Warren Buffett’s Berkshire Hathaway (BRK-A). Buffett is widely recognized for possessing those qualities in ample quantity.

So we eagerly wanted to believe Paulson and pal Ben Bernanke from the Federal Reserve when they promised to be transparent and subject to oversight in the Congressional hearings for the $700 billion Troubled Asset Relief Program (TARP).

In late October, I wrote about Paulson’s statement, “The program right now is for banks and thrifts.” I was alarmed to see his qualifier “right now.” It indicated to me that he was already thinking of a future where other types of institutions might dip into the bailout coffers.

I speculated that the precedent set by Long Term Capital Management’s bailout in 1998 would rear its ugly head again as hedge funds “too large to fail” will line up right behind Citigroup (C), American International Group (AIG), Bank of America (BAC), and Morgan Stanley (MS) for the Wall Street version of the bread line. In this case, the “dough” is taxpayer money. Anything to stave off a recession and a painful bear market right?

Turns out that Bernanke and Paulson have been less than forthcoming. Bloomberg News has sued the Federal Reserve citing the Freedom of Information Act to obtain records regarding the implementation of TARP. The Federal Reserve and the Treasury have been collaborating on a surprisingly leak-proof information embargo.

As a result, the public possesses only sketchy information about where the $700 billion is going. Only a few recipients of the relief funds have been disclosed. Even more troubling, we don’t know what kind of securities the banks or other recipients have pledged as collateral. What kind of deals are being made? What is there to hide?

Some say that the loans have to be made in confidentiality so as to shield troubled financial institutions from more panic selling of their stock, especially from rapacious short sellers. I say rubbish, this smells like the stuff Paulson used to spread around on his farm. The government has already imposed temporary bans on short selling of financial institutions stock (which I think was unconstitutional or at least inconvenient as I regularly hedge my investments with shorts); it could extend those bans to protect vulnerable banks.

My guess is that improper loans to hedge funds have been made. I hope I’m wrong, but the “too big to fail” rationale can be temptingly applied to gigantic hedge funds with trades and derivatives positions so heavily leveraged and so intertwined with mainstream financial institutions that failure would be too catastrophic for our overall economy. Bernanke and Paulson may have no choice.

The secret fear on Wall Street lies with impending but unknown hedge fund redemptions. This could happen if poor hedge fund performance compel already fearful investors to pull their money. In early November, I pointed to the distinct possibility that we could fall deeper in this bear market from heavy hedge fund redemptions. Paulson and Bernanke have already shown a reluctance to suffer pain and a willingness to do whatever it takes to avoid pain. They are merely compliant doctors we’ve ordered to keep the painkillers coming regardless of the risks of addiction or decreased efficacy.

There is some evidence surfacing that hedge funds are indeed struggling in this environment. Theoretically, hedge funds should do well or at least less poorly during market downturns. Whatever happened to hedging?

Hedge funds are the private domain of the ultra-wealthy. The average American taxpayer should not be getting into that business. Unfortunately, like Bernanke and Paulson, the average American taxpayer may have no choice.

That qualifier, “right now,” is what has me worried that our well-intentioned public servants will find it difficult to ignore the inevitable cries for mercy and help from their hedge fund brethren. Paulson is leaving himself the option of opening the program up to hedgies sometime in the future, when the most leveraged hedge funds with an intricate web of derivatives trades come calling for help are “too big to fail.” The average American taxpayer, while deemed unsophisticated enough to make direct investments in hedge funds will finally be able to own some of these exotic bad boys through our government proxies.

In the 1990s, a hedge fund called Long Term Capital Management promised to generate excess returns with minimal risk through the use of sophisticated financial models and formulae devised by a team full of PhDs and Nobel Prize laureates. Sounds seductive doesn’t it? It certainly was seductive enough that investors put in over $1 billion before the fund started trading in 1994, a huge starting coffer even by today’s standards. The short story of LTCM is that it made extremely leveraged trades with an intricate web of trading partners that, while highly profitable in the beginning, turned out horribly wrong. The fund suffered tremendous losses and teetered on the edge of outright failure. The Federal Reserve orchestrated a bailout in 1998 of over $3.5 billion. LTCM’s highly leveraged derivatives trades were made with so many counter-parties in the financial world that a Darwinian approach would have had much wider repercussions. The risk of a more widespread collapse of the financial markets loomed as a distinct possibility. LTCM was simply too big to ignore and not bail out.

So the precedent was set exactly 10 years ago. Today, the scary prospect of hedge fund failures acting as catalyst for another leg of decline in the markets is very real. We are collectively hyper-focused on the credit crunch, falling real estate prices, and Main Street’s inability to pay the mortgage. Few can see around the corner when imminent hedge fund failures will send shock waves through the system and drive us deeper into this bear market. There are now at least a dozen LTCMs out there, all crossing their fingers that their limited partners won’t request withdrawals. If the LPs bail en masse, Mr. Paulson as the taxpayer’s agent will bail out his hedge fund buddies.

Interestingly, Warren Buffett’s Berkshire Hathaway (BRK-A) teamed with Goldman Sachs (GS) to offer an alternative plan to the principals of LTCM. Ultimately, LTCM went with the government sponsored rescue. I wish it went down differently. If we’re going to spend taxpayer money to bail out hedge funds, and I’m betting we will, we should find private partners who can share the risk with the public taxpayer. We could give incentives for large private players like Buffett, who have the talent and financial heft to collaborate on a bailout, to help us carry the load. So what if a few fat cats get a little wealthier, I’d like to see the public taxpayer not have to foot the entire bill.