What neither the Congress, Paulson or Bernanke have made clear is that this 'bailout' plan is NOT going to cost $700 billion. Not even close.
First of all they should have called it a bailout plan because a) its not that accurate and b) it sounds terrible on Main Street
What this plan is envisioned to do is to create a market for distressed debt that is severely weighing on bank balance sheets. How severe is this? Wachovia was talking about BUYING investment banking giant Morgan Stanley a week and a half ago. Today THEY had to be BOUGHT OUT by Citigroup. Banks aren't lending to each other and no one wants to lend to banks for fear of the other party failing. The central bank windows have become the only lenders.
The Paulson plan will take many of these assets off the books of the banks so they can start anew. Here's a hypothetical example:
Let's say a $10 billion slice of these problem loans is trading at 30 cents on the dollar. This assumes that 70% of the loans will default. A 70% default rate it on virtually any package would be extremely unlikely. So the Treasury will bid 40 cents on the dollar for this debt. If an institution has already marked the loan down to 30 cents they are likely to sell as it gets it off their books at a mark-to-market profit. Now they will have lost 60 cents on the investment but its better than all of it. Treasury can hold this until maturity or eventually sell these assets out. If other buyers want to come in ahead of the Treasury and bid higher that would be fine.
Ultimately it is quite possible for Treasury to be selling purchased assets at a profit. It's important to remember that panic market pricing does not necessarily represent value and for any but the most absolutely toxic group of loans to default 70% is very unlikely. [The absolutely toxic stuff should be bid at 5 cents on the dollar]. The long term cost of this is unknown at this point but the taxpayer could end up being flat on this. Even a 100 billion dollar loss which prevents a deep recession is well worthwhile.