Unless you’ve been hiding under a rock, you surely know about the public outrage against the pending $700 billion bailout of Wall Street package currently being considered by Congress.  Why should the average American who angsts over gas prices put her hard earned dollars up to bail out Wall Street banks, who have cashed out to the tune of billions of dollars during the housing boom.  However, putting aside the blame (even though there is a lot to go around), this is what this country needs to get us out of this credit mess.  Why?  Basically, banks and depositors don’t trust each other now, and credit is extremely tight.  No one knows if the collateral on banks’ balance sheets are worth what they say they’re worth, despite repeated markdowns.  Banks are deathly afraid of incurring more loan losses, particularly given what has already happened to Bear Stearns, Lehman Brothers, AIG, retail bank Washington Mutual, and potentially Wachovia, one of the largest commercial banks in the country.  This is where the $700 billion package comes in.  Banks are afriad to lend to one another and to you, the average homeowner, small business owner, car buyer, etc.  If the government comes in and buys those mortgages and takes them off the books of the banks, they are free to rebuild their balance sheets and other financial institutions will have more confidence to start lending to one another.  Moreover, the bank account holders like you and me won’t be so freaked out that we run to our bank and withdraw all of our deposits.  The banking system will stabilize and the credit freeze will start to melt.  Businesses will once again be able to borrow against lines of credits, payrolls will be met, and financial commerce will continue. 

The big question is:  will the American taxpayer be stuck with hundreds of billions in losses?  Not likely, IF the Federal government acquires the mortgage securities at a significant discount, marked down to what healthy banks are currently paying for the assets of failed banks.  The government will likely hold these mortgages for some time as the economy slowly recovers.  Despite the wave of foreclosures, housing prices aren’t going to zero.  At some point, when confidence in the economy is restored, housing purchases will pick up.  The housing market will strengthen and unemployment will decline.  In turn, the mortgage securities will become more valuable as the underlying assets increase in price.  Under this scenario, the plan may indeed be an excellent long-term trade.  Warren Buffet has commented that this is what he would do if he were there. He’s been right more times than he’s been wrong.