Republican and conservative apologists for the bailout consistently push the vain hope that somehow taxpayers might yield a profit out of the Paulson plan. In their simplistic analysis, they argue that all Treasury has to do is buy up a bunch of failed mortgage securities at some discount, say 20 cents on the dollar, and later sell them back to the market when things are normalized.

The problem with this analysis is that it doesn't take a complete view of the portfolios of these companies. What's really killing these investment banks and large insurers is the credit default swaps they sold to other counterparties for credit risk mitigation. For example, a big investment house like AAA would use its privileged credit rating status to take on the risk of a particular company's default, like B-rupt Inc, by selling a swap as insurance to company Clueless, who is seeking to mitigate that risk (the credit risk never goes away, it is merely transferred to seller of the swap). Now when the market finds that B-rupt's financial situation is improving, the swap instrument will decrease in value in favor of AAA; while when the market determines B-rupt's situation is declining, the swap will increase in value to Clueless. Hence, AAA is considered short the swap position. Thus, when the market determines that B-rupt's financial condition deteriorates to the point of near bankruptcy, the value of the swap to Clueless increases dramatically. If AAA wants to cut its losses short, it will have to sell the swap at a substantial loss to get out of it. Since it doesn't want to face the music on a bad bet, AAA asks its friend in the Treasury department to do him a favor allow AAA to buy back the short swap position at a discount so AAA doesn't go insolvent.

In order for the bailout to work to stave off short-term insolvency, Treasury will have to take opposing transactions (either buy or sell) with a potentially insolvent entity to the point where it is no longer imminently insolvent. The difficulty is that the proposed bill says nothing about Treasury entering into a short swap position (not that it would stop them), rather it merely allows for purchases, thus the only other way to shore up these wrecked portfolios is to pay a higher price for the other assets in the portfolio, like the mortgages. In other words, instead of paying a discount on the mortgages, Treasury will have to pay a higher price, up to whatever price staves off default and not where the market might evaluate them. Which leads us to two scenarios. First, the if the insovlency clearing price is higher than the market price of a mortgage, then Treasury will give the institution the insolvency price. Further, if the insolvency clearing price is lower than the market price, as a captured entity Treasury will still give the troubled institution the market price. Some might argue that this situation could lead to a wash, while I'm betting these institutions are in such disarray, that the taxpayer will begin upside down with these Treasury transactions.

The problem is that nobody knows unless they get a look at the portfolio. Congress is being asked to buy a portfolio it can't see, and are being assurred by Republican apologists that there might be a profit. Only a sucker would pay $700 billion for a portfolio without performing due diligence. Unfortunately, that sucker will given no choice since this is really highway robbery.