The bailout, like others before it, is an attempt by the Fed to remove enough of the toxic mortgage debt from the balance sheets of the most exposed banks to keep the system appearing financially sound, although weak at the moment. Complete collapses of the largest banks in the country may correctly induce runs on the remaining banks. If people realize that they are not the only ones facing financial ruin and foreclosure and pull their money out of the banking system, the largest financial institutions could not survive without even great bailouts.
These banks have already burned through much of their reserves to cover losses resulting from exposure to the mortgage crisis and have borrowed as much as possible from each other and foreign investors. The fire sale of American companies to foreigners may be just beginning, but they will not buy if our institutions are facing bankruptcy. While credit from other banks has been drying up, the Fed has been turned to as the garbage dump of last resort for these banks and their nonperforming, highly inflated mortgages.
For now, these debts still retain a small semblance of officially-recognized legitimacy through the bond rating agencies, so the Fed is more than willing to keep up the charade by trading Treasury Securities for them. Slightly better money (dollars, Euros, Swiss Francs, and other currencies) will be used to chase after very bad money at the expense of those who hold the better money.
So the banks will be able to move $200 billion worth of bad debt off of their balance sheets in exchange for new loans from the Federal Reserve in the form of Treasury Securities, which will prop up their dwindling reserves and make them appear solvent. But it is very doubtful that this action will really fool anyone who owns a home, lives in a neighborhood, or invests with banks, hedge funds, or other institutions that are exposed to the mortgage meltdown.
The mortgage crisis has now spread far beyond just a few regional markets and has infected over 200 markets across the nation. Florida and California now have at least 33 soft markets each in various counties and cities as the values in certain areas rose faster and higher than in other communities. These are the markets where much of the bad debt will come from to be traded in at the Fed. (Otherwise, if these banks held mostly good debt, they would not need a Federal Reserve bailout in the first place; therefore, the debt must be coming from these distressed and severely distressed markets.)
The Federal Reserve, though, will be giving the banks loans even as their previous loans fail spectacularly. The inflation will continue pushing up costs for consumer goods, including food, energy, and everything derived from energy (everything else in the economy, mostly). But at least homeowners having trouble making their mortgage payments or keeping the heat on or feeding their families will be able to rest assured that their bank will not feel any financial pain from kicking them out of their homes.
And as the values of these inflated properties continues to fall, and more houses remain empty on the market for longer periods of time, the restrictive bankruptcy laws may just push even more homeowners towards giving up on their increasingly worthless homes. This is the financial and legal environment that the banks set up for themselves. And just as designed, it will be the public who will lose their homes and bear the costs of bailing out the banks.