Myths about the bailout

Myth #1: Ordinary taxpayers would have to pay for the Troubled Asset Relief Program (TARP).

Myth #2: It would reduce the value of the dollar.

The truth:
The government probably wouldn't have to print money, raise taxes, or go into deeper debt to do it. Instead, the government would be sucking in $700 billion of mortgage bonds while spitting out $700 billion of Treasury bonds. It would simply trade one asset for another of equivalent market value.*

The government probably wouldn't be giving Treasury bonds directly to banks in exchange for mortgage bonds. Instead, it would likely pay cash for the mortgage bonds and then sell an equivalent amount of Treasury bonds onto the open market. However, there would be no significant change in the monetary base.

Warren Buffett has pointed out that current buyers of mortgage-backed securities are expecting to earn an annual rate of return of at least 15%. He said that the government should be able to earn at least 10%, as a conservative estimate.*

As of Friday, 30-year Treasury bonds were yielding about 4.4%. If Buffett is right, this means that over the long run, the government should be able to earn a net annual rate of return of 5.6-10.6%. With $700 billion invested, this translates to a gain of $39 billion–$74 billion per year.

Of course, there is risk of a loss—even a big loss. However, the odds are in the government's favor.

If this is a boon for the government, why would banks go for it? It's simple: weaker banks would be giving up higher returns in the long run for greater stability in the short run.

Update: I should have said the government won't have to go into deeper net debt. It would go into deeper debt, but it would use the debt to buy assets of the same value. This is a lot different than going deeper into debt to finance current spending, as the government usually does.

* This assumes the government buys at market prices, rather than following Bernanke's stupid idea of overpaying.