The fundamental reason house prices must go down is that incomes cannot support current prices. In the aggregate, families with gross income $80K/year cannot live in $600K houses (median numbers representative of parts of California). This house-price to income disparity is the primary cause of the credit crisis. Making more credit available will not help with the primary cause.

There is a possibility that taxpayers could make money on the bailout deal, even if, as Dean predicts, housing prices do not recover to 2006 levels. It all depends on what price the bad securities are purchased for. At the bottom of a panic, nobody wants to touch a disfavored asset, so the value is close to zero. The ultimate recovery may be higher.

For example, if Treasury buys $100 (face value) of CDOs for $20, and in 5 years they're sold for $40 because of a partial housing market recovery, the government will double its money. (This wouldn't require housing prices to double -- just a change in the payment profile of the CDO.) If, in addition, the government gets $10 of stock warrants in the issuer and, after a partial recovery, they're worth $20 in 5 years, that's another $10 of profit. There's no guarantee of this, but similar things have happened after past busts, as with the RTC's assets.

In this scenario, it's the equity-holders in the financial services companies who have taken the hit by selling their assets at a heavily discounted price and/or getting their equity diluted.

The contention that the financial paper is really worth more than its current market valuation is just weird. The bailout as proposed by Paulson is supposed to preserve the free-market system, which is usually claimed to know better than government commissars or bureaucrats what things are worth and what decisions to make. Now the government employees Paulson and Bernanke and a few other elite commentators say they know better than the market, and consequently they must be made into commissars. Apart from the contradiction with their supposed principles, Paulson and Bernanke haven't shown any signs of actually understanding what things are worth or anything else in this crisis.

Following up the dot.com disaster by intentionally inflating a housing bubble is the fault of Greenspan and the Banksters who are now crying for a taxpayer funded rescue. This kind of money would be better spent on a nationwide conversion to solar energy and tax credits for people to purchase environmentally responsible transportation like the electric bikes sold at www.greenflyerbikes.com
http://www.youtube.com/watch?v=kLdnW5Vi5wk&NR=1
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It is a waste of time, and an impossible task, to specualte whether the US will profit from the Slush Fund until Someone explains at what price the Slush Fund will actually purchase assets. Is the intention to pay at, above, or below market prices?

I think Tortoise makes the key point. By traditional standards, an honest mortagage on a $600k house with 20% down requires an annual income in excess of $120k/year.

Having followed housing (for trade magazines) since 1985 or so, I can say with sonme authority that all hands knew a bubble was building but nobody saw any monetary to be had by bursting it. By 2003 we were already challenging National Association of Homebuilders statistics but editors would not run the stories. For the interest of all, our slightly-less-than rocksolid research suggested from 2002 through 1004 the percentage of new single family homes sold to "investors" was something like 35%. By 2006 our trade association sources say 46% of ALL home sales (new & resale) were creatively titled "2nd/34d/4th homes" rather than investments. Demand stimulated by Greenspan's easy money policies drove prices up, as did collusion between mortgage originators and appraisers.

I have no data, but it seems reasonable to me that a substantial portion of these home investors are first wave boomers seeking to recover retirement funds lost in the dot.com bubble. With 10-12 earning years left (in 2002) and no faith in stocks, real estate was a natural alternative investment. Now that real estate is underwater and the revised Bankruptcy statute allows mortgage servicers to go after the aging investors' remaining retirement savings plus future pension benefits. That's going to put blood in the streets and it won't be pretty.