This was, without a doubt, the most poorly marketed plan in the history of man.  From the term “bailout” to letting Paulson try to shove it down people’s throats.  Why isn’t this a “bailout” you ask?  Well….

Companies are being forced to mark their books to market. So, they’re writing down the value of their long-term mortgage related assets which reduces shareholder equity on the ledger. This forces the firms to raise capital in order to remain technically solvent.  They must maintain positive shareholder equity or else the firm is likely on the brink of disaster.  The government’s plan is to come in and essentially replace the bad debt with treasuries.  If you can reduce the write-downs you can save many of the banks from being forced to write-down assets (assets that will certainly be worth substantially more in 5 to 10 years) and give them time to work through the problems.   The problem with many of these banks is that they’re simply not large enough to house this debt at the rate that its value is falling.  So, for instance, AIG was forced to mark billions in credit default swaps down after Lehman failed, but they didn’t have the short term cash to meet the liabilities.

So, the government has the correct solution. Not the BEST solution, but it gets to the core. They will essentially trade the bad paper for good paper and it will alleviate many of the pressures on the banks. As I have written here many times the banks are the lifeblood of the system.  I like to think of the banks as the oil in the engine.  If you run out oil the system begins to break down and eventually the engine stops running.  You can’t have a healthy functioning economy if the banks aren’t lending.  So, we’re not “bailing out” the banks – we’re actually rescuing the entire system.