But before we can get into criticism of the bailout, let's understand exactly what is happening.  Knzn has a great post explaining how all of this will actually work. 

First of all, today’s taxpayers are certainly not going to come up with the money, not by any stretch of the imagination. There are no plans to raise taxes to pay for this bailout, nor, in my opinion, should there be. (That’s not necessarily to say that taxes shouldn’t be raised, just that this bailout should not be the deciding factor.) People (and institutions mostly, really) who buy Treasury securities will come up with the money. The Treasury will issue new Treasury securities to raise the money to pay for the distressed securities that it buys. Most likely the banks that sold those distressed securities will buy the new Treasury securities with the proceeds from the sale, so nobody really has to come up with the money, except for a few minutes while the deals are being done. In effect the Treasury will be paying for the distressed securities by creating its own securities to use as payment.

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And – here’s my main point – the Treasury will not be paying full price for these securities. It won’t be paying anything remotely close to the price that the securities were issued at. It will be paying whatever price desperate banks are willing to accept in order to get the securities off their books and replace them with things that can be easily sold when they need cash. These are motivated sellers we’re talking about. In all probability, many banks will be willing to sell these securities for less than they think the securities are really worth. Because they don’t want to take the risk that, when the government bailout is over, they will have some need for cash and won’t be able to sell the securities then.

Granted, there may be some banks that figure out ways to game the system and sell their securities for more than they are worth. But all in all, we should expect the Treasury to get these securities at something close to fair value. The Treasury is not just throwing money away; it’s buying valuable (though quite risky) assets and paying roughly what those assets are worth.

And it’s important to understand that “fair value” includes the expectation of a substantial risk premium. The fair value of a junk bond is considerably less than the fair value of an otherwise similar investment grade bond, but when they mature, both bonds are redeemed at par. The junk bond has a larger chance of default, but even when you take that chance into account, the expected return on the junk bond is considerably higher. People don’t buy junk bonds because they’re stupid; they buy them because they expect, on average, a high return. Similarly, the Treasury should expect, on average, a high return from its purchases of distressed securities.

So, while there is (in theory, at least) quite a large risk to (future) taxpayers (a risk of up to $700 billion – plus the meager interest that the government has to pay), the expected return is not only positive but rather large. And since the interest paid on Treasury securities is quite small, that return, if it materializes, will be a huge windfall for whatever future taxpayers get the benefit.

So this “bailout” is not about the Treasury paying $700 billion and hoping to recover some of it in a best case scenario. It is about the Treasury paying $700 billion dollars, risking losing up to the whole amount, but expecting not just to recover the entire amount but to emerge with a large profit. The Treasury is, in a sense, gambling with taxpayers’ money, but the gamble is a good bet, kind of like if you had inside information about the horse. Of course, making a profit is not the point of the operation, but it might be a pleasant side effect.

To sum up: (1) nobody is proposing that taxpayers pay for all of this today, (2) we will likely profit from the purchase of all these "toxic assets" so we will not burden future taxpayers either. 

The best criticism of the proposed plan seems to be the worry about giving the Secretary of the Treasury the power to simply buy "mortgage related assets" as he sees fit.  So the question is, how much will he pay for these assets?  I originally thought, and Knzn seems to agree that banks would be all too happy to unload their bad assets on the government for bargain basement prices. This will probably be what happens.

But it would be entirely possible, under this legislation, for Paulson to pay higher than fair prices, or give favorable prices to certain institutions.  This could be good for getting us out of the current financial crisis, but in effect we'd be rewarding those institutions that got themselves into the deepest mess, and punishing "the taxpayer."

This criticism, while true, is really a empty one though.   If we could draft into law what a "fair value" would be for all of these different kinds of mortgage related assets there really won't be a financial crisis.  Banks would happily trade them among each other at this "fair value."

Finally, will this bailout hinder future administrations?  Some say this bailout pushes the reset button for all spending projects currently proposed by the candidates.  Not likely.  This will hinder Obama or McCain to the extent that they care about the size of the US debt which already stands at about $10 trillion.  Since neither candidate was seriously proposing reducing the debt I don't think they'll mind too much.