I've been thinking about what's likely to happen with this financial mess we're in, and I'm not very optimistic.
The root cause is over-inflated housing prices. Too many people bought too many houses for too little cash up front.
Possible solutions to the problem:
A. Keep housing prices high by increasing the demand for houses.
B. Keep housing prices high by decreasing the supply of houses.
C. Let housing prices keep falling until demand meets supply.
D. Ramp up inflation so that house prices stay stable (but the price of everything else goes up).
The bailout is plan "D". $700billion is going to magically appear and go into the financial system to prop up failing mortgages. A trillion or more is already committed to propping up Fannie and Freddie and AIG; all that money going into the system means more inflation.
The politicians would never choose options A, B, or C. "A" basically means you need more people here to buy houses, and I don't see any political will to adopt a more lenient immigration policy.
"B" would make for really bad PR-- "The department of Housing and Urban Development bulldozed 600 foreclosed homes in Detroit last month..." might be sound economic policy but it makes for heart-wrenching pictures on the TV news.
"C" means more foreclosures and middle-class people feeling poorer because their $350,000 home is suddenly worth only $200,000. That ain't gonna fly.
The beauty of plan "D" is that it's mostly painless for the politicians. The $340,000 6% mortgage on your $350,000 house will be worthless to the bank when inflation is at 10%, but it's a very good deal for the middle-class home-owning taxpayer. If wages don't keep up with inflation, or if taxes have to be increased to pay for all this, then they'll be worse off, but that's a problem the next administration can deal with.
I can't figure out how they're thinking they'll avoid more bank failures in a higher-inflation economy, though. I've got a 30-year fixed-rate mortgage with Florence Savings Bank at 6% interest that will be less than worthless to the bank (it's "net present value" will be negative) if inflation climbs above 6%. Do small banks hedge their inflation risk somehow?