Earlier this week, Hank Paulson forced the nine top banks to take $125 billion in taxpayer money in exchange for perpetual preferred stock that pays a 5% yield, which rises to 9% after five years plus warrants to buy 15% of the banks' stock. Does this mean that the banks will now start lending out that money to get the economy off its back? Absolutely not. It could go to paying banker's bonuses instead.

And why not? After all, the write-offs of sour investments have more than wiped out all the "profits" these banks reported over the last three years -- during those boom years they reported $305 billion in profits and have recently taken $323 billion in write-offs. And with more losses looming, the top nine banks need to raise $275 billion more.

How much of these reported bank profits were faked to boost banker's bonuses? Why are the bankers who booked these lousy deals keeping the multimillion bonuses they got during those years? And why did Paulson decide to inject taxpayer money into these banks if they're not going to use it to boost the economy?

Ever since this mortgage mess started I've been wondering what lit this catastrophic fire that has already destroyed so many major financial institutions, as well as the lives of millions of Americans who have lost their homes to foreclosures. While we've talked about the abuses of the mortgage mess, the true culprit is the easy money that was made available.

An asset bubble needs easy money in order to inflate the bubble and today's New York Times makes a good case that a 2004 rule change by the SEC gave the green light to major U.S. investment companies. This rule change lit the match that fueled this entire mess. So let's take a look at what the change is and how failures to use the tools available to the SEC led to our current disaster. And, by the way, our current Treasury secretary, Henry M. Paulson, Jr., headed Goldman Sachs (NYSE: GS) at the time of this disastrous rule change. Goldman was one of the five investment banks that pushed for this change.

In 2004, investment bankers wanted an exemption from an old tried-and-true regulation that limited the amount of debt they could take on. They thought they were grown ups who should be trusted to know how much risk they could take on and how they would control this risk to preserve their companies. Five commissioners of the SEC decided to believe them and quietly changed capital rules freeing up the companies to make their own debt level decisions. To make matters worse, they established a program that let these banks police themselves.

The Oracle of Omaha, Warren Buffett, of Berkshire Hathaway (NYSE: BRK.A) spent a few moments on CNN answering some key questions about the economy at a Fortune Magazine Forum. He was asked where he would place the blame for the current financial crises being played out on the world stage, and he said he is not one to point fingers. There is plenty of blame to go around.

Initially Buffett quipped that "every saint has a past, and every sinner has a future." He went on to say that the everyone participated in the creation of the housing bubble with the unrealistic expectation that prices would continue to rise.

He summarized that home ownership is worshiped in the United States, and once cheap funding became available and prices started to rise there became the feeling that if you did not buy a home now you would be facing higher prices next year and perhaps less favorable interest rates as well.

Let me get this straight: the Democrats are backing George Bush's $700 billion rescue plan that Republicans oppose. These are strange times.

House Republicans have many gripes with the plan. They are pushing to fund the recovery of financial services companies with private capital. Others are raising worries about the cost and the timing of the rescue. These are all valid questions.

Then there's the presidential campaign to consider. John McCain is threatening to skip tomorrow's presidential debates unless a deal on the bailout is reached. Maybe Republicans are throwing up roadblocks so McCain can swoop in and solve the impasse, looking presidential in the process. Barack Obama is also using this bailout for his political gain.

Meanwhile, Democrats are pushing for relief for cash-strapped homeowners. So far, they are not getting much sympathy from the Bush administration.

Treasury Secretary Henry Paulson recently said "the vast majority of foreclosures in this country ... are coming from people who either don't want to stay in their home, took out loans they couldn't afford as the result of irresponsible lending practices."

That's bologna, according to the Center for Responsible Lending, which says that the vast majority of people want to stay in their homes and could afford to if the courts were allowed to modify mortgages. Consumer advocates back the idea as do most Democrats. Bankruptcy judges think it's a good idea as well. The mortgage industry and some fiscal conservatives oppose this provision, arguing that it rewards people for making bad investment decisions.

At perhaps the most critical moment in his presidency, George W. Bush looked into the teleprompter tonight and warned the American people that very bad things would happen to the economy unless Congress passed the $700 billion bailout for Wall Street.

Kudos to Bush's speech writers. He explained the credit crisis fairly succinctly. Of course, he neglected to mention that his administration's opposition to sensible regulation laid the groundwork for the financial maelstrom. That's an issue, though, which will be debated by historians for decades to come.

Details of the bill are still being hammered out. The administration has agreed to caps on executive pay on firms who seek assistance. Some sort of plan to give taxpayers an equity stake in firms that the government helps also seems likely, according to a The New York Times.

The president had little choice but to reach across party lines because members of Congress were not buying the bill of goods being sold by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. Paulson, in particular, showed remarkably poor political instincts by insisting that the bailout be approved as written. Whoever told him that Congress would give him a $700 billion blank check was crazy.

Meanwhile, the crisis is becoming the top issue of the presidential campaign. Republican John McCain today suspended his presidential campaign and called for Friday's presidential debate to be postponed. This is a stunt. McCain and Barack Obama do not sit on the relevant committees dealing with the crisis. Their presence in Washington will have little impact on the development of a deal.

Postponing the debates is an especially bad idea. The American people need to hear the plans McCain and Obama have for the economy. My colleague Peter Cohan points out that McCain has said many things about the economy such as "the fundamentals of the economy are strong" which he probably now regrets.

As I was looking over the Paulson plan for the fifteenth or sixteenth time (what the hell -- it's only three pages long), I was struck, yet again, by its incredible vagueness. Moreover, watching the good secretary battle Congress and hearing the statements of various Congressional lobbyists, I continue to be amazed by the degree to which Wall Street seems to be trying to defraud the American people. According to Paulson, placing caps on executive compensation (aka "golden parachutes"), subjecting the Secretary's decisions to judicial oversight, giving the government an equity stake in the companies that it helps, and setting a firm end date to the program are all "deal breakers." In other words, the Secretary is convinced that companies will refuse to accept a federal bailout if these conditions are attached.

Wow. Did I miss something? Weren't Paulson and Fed Chairman Ben Bernanke just saying that a bailout is the only thing that will save the economy from a catastrophic meltdown? Now, apparently, some financial companies have determined that a full-scale collapse of the U.S. economy is preferable to leaving a job without sufficient bonuses and separation packages. Rather than tell the heads of these companies to stick it in their ears, however, Secretary Paulson is suggesting that America's taxpayers need to cave in to their demands. This seems so amazingly shortsighted, so incredibly illogical that I began to wonder if there might not be another reason that the Secretary of the Treasury is demanding what seems to be tantamount to financial blackmail.

Howard Rodman suggested a bizarre scenario: he theorizes that Secretary Paulson left his job as CEO of Goldman Sachs in anticipation of this crisis. Hank then went to work for the Treasury in order to orchestrate a major rescue of Wall Street. Having coerced the Federal Government into buying billions of dollars of worthless securities with minimal oversight and provisions, he would subsequently return to Goldman Sachs where, presumably, he would be heavily rewarded for his good work in betraying the public trust.

It's official: Main Street does not believe that Wall Street deserves a $700 billion rescue from Congress.

By a margin of 55% to 31% in a Bloomberg/Los Angeles Times poll, American said that they don't believe the government should "bail out private companies with taxpayer dollars, even if their collapse could damage the economy," according to Bloomberg News. That's a stunning rebuke to the Bush administration.

Though Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke are thumping their chests demanding that Congress act immediately to head off the worst financial crisis since the Great Depression, members of Congress are not so sure. Senate Banking Committee Chairman Chris Dodd (D-CT) indicated to reporters yesterday that passage of the bill this year was not a sure thing. Maybe that's political posturing, but it should scare investors nonetheless.

Democrats and Republicans are getting hammered by outraged constituents questioning why the government should bail out sleazy Wall Street bankers and not lift a finger to help homeowners hurt by the credit crunch. The American people have nothing against people getting rich. They do resent those, however, those who they believe cut corners, which is exactly how Wall Street got into this mess. Anti-bailout sentiment is so thick you can cut it with a knife.

The administration is wasting Congress's time with all the testimony about "the crisis" and its need for $700 billion in our money. Free markets got us into the current situation -- the market adjusting after taking on too much debt. Let free markets get us out.

First, Paulson is new to politics -- though as Goldman Sachs Group (NYSE: GS) CEO he was very successful, such success does not always translate into Washington wins. He lacks the stagecraft needed to persuade Congress and the American people of his position. Simply repeating over and over again that Congress must pass his $700 billion plan now is not working. The world has not collapsed since he decided to launch his sales campaign. Every day that goes by with the world's financial markets still intact begs the question: "Exactly what is the financial crisis that Paulson is trying to stop?"

Granted, there is some fear priced into the credit markets, but less than there was last week. Fortune reports that Treasury bill yields are still low since investors piled into them for safety -- but those yields are higher than they were before -- rising from 0.03% last Wednesday to 0.83% yesterday. And the so-called TED spread -- the gap between 3-month Treasury and 3-month bank lending (LIBOR) rates -- remains wide -- 240 basis points (100 basis points = 1%). But that's down from 288 basis points last Wednesday. I look at this situation and do not see imminent collapse. Instead I see rational investors deciding that more debt will not solve a problem caused by too much debt.

Remember that old joke that a conservative is a liberal who got mugged? Well, maybe we can now say that a socialist is a free marketer who just got a $700 billion government bailout.

Lost among all of the talk about whether Hank Paulson and Ben Bernanke have become the new overlords of the American economy, is discussion about helping save homeowners from the Bush administration. All that was said is that homeowners want the U.S. Congress to pass the rescue bill quickly.

Democrats in Congress have other ideas. Sen. Chuck Schumer (D-NY) told Fox News Sunday that " we have to do something about the mortgage crisis, not just foreclosures but the price of housing."

Schumer makes a good point, but figuring out what to do is tricky. More must be done. The consequences of massive foreclosures are too big to ignore.

I have heard the arguments before that we should not reward speculators and people who bought homes that they could not afford. That sounds great if we lived in a free market utopia. But as the last few days have illustrated, the free market ain't what it used to be.

Bloomberg News reports that Washington pulled another Sunday night special -- wiping out Wall Street as we have known it. Ironically, this move will put Wall Street back where it was prior to the Great Depression. How so? Last night the Fed approved changing Morgan Stanley (NYSE: MS) and Goldman Sachs (NYSE: GS) from investment banks to commercial ones. Morgan Stanley -- which may sell up to 20% of itself to Mitsubishi UFJ and may put merger discussions on hold -- and Goldman Sachs now have greater odds of remaining independent.

Most significantly, the change will allow both banks to take consumer deposits and get short-term loans from the Fed. In exchange for that cheap money, they will need to increase the amount of capital they have, take less risk, and submit themselves to tighter regulatory scrutiny. The capital increases are the most significant piece of this new puzzle. According to the New York Times, "Goldman Sachs has $1 of capital for every $22 of assets; Morgan Stanley has $1 for every $30. By contrast, Bank of America (NYSE: BAC) has less than $11 for every $1 of capital." Goldman and Morgan will be required to raise significant capital to reach that 11 to 1 ratio. How they do that still remains a mystery.

Ironically, prior to the Great Depression, banks like JPMorgan operated both commercial and investment banks -- taking deposits from consumers and doing stock offerings for business. I was surprised to learn that they already have billions in deposits. "Morgan Stanley had $36 billion in retail deposits as of August 31 and Goldman Sachs had $20 billion," according to the Times. Now, they'll need to add branches and invest in marketing and systems to expand that amount. So, although the industry will return to its pre-Great Depression structure -- it will be more tightly regulated than it was back then.

Years from now, analysts may look back on the actions of Henry Paulson, Ben Bernanke, and their colleagues and say that they saved the economy from an unimaginable fate.

Or, that may not happen at all. The plan to buy toxic assets from banks and put them into a government fund could be damaged by change forced on it by Congress. The debate could delay the help for weeks.

The plan may also be deeply flawed.

There are several potential issues that could make the medicine worse than the disease. One question is: Who gets saved? Banks? Small-town banks? Brokerage firms? Credit unions? College endowments? Hedge funds?

Congress may not like the idea of saving hedge funds where some managers make hundreds of million of dollars. But, if those funds cannot rid themselves of their troubled paper, they may be forced to sell tens of billions in other asset to stay in business. Another round of panic selling could be an unintended consequence of Paulson's program.

If the government miscalculates who should be thrown a life line, the mess could return.

Douglas A. McIntyre is an editor at 247wallst.com.

Financial stocks, which have been bloodied over the past few weeks, rallied today on the plan announced by Treasury Secretary Henry Paulson for the government to acquire troubled bank assets. The recently announced ban on short-selling helped the shares as well.

Goldman Sachs Group Inc. (NYSE: GS), down 40 percent for the year, rose $20 to $128 in mid-morning trading. That's about an 18 percent rise and comes a day after the stock hit a 52-week low. Remember, Goldman recently reported a 70 percent decline in third quarter profits which given the billions of write-offs taken by its competitors is almost miraculous. Maybe Paulson decided the government needed to suck away the bad investments from their balance sheets when he saw pressure building on his old firm.

Today's 25 percent raise in Morgan Stanley (NYSE: MS) may alleviate some of the pressure on the investment bank to find a merger partner to avoid the same fate as Lehman Brothers Holdings Inc. and Merrill Lynch & Co. (NYSE: MER). Shares in the New York-based company rose $5.28 to $27.83. Morgan Stanley reportedly is mulling a tie-up with Wachovia Corp. (NYSE: WB).

Even Washington Mutual Inc. (NYSE: WM), another company that might get a multi-billion buyout, got a boost, soaring 81 cents to $3.80. That's an increase of more than 27 percent. Of course, the 52-week high is $39.25, so any celebration is muted.

The joy from shareholders about the Paulson buyouts is palpable. Taxpayers are more sanguine. The one thing I remember from Economics 101 -- where my professor used to always use marijuana joints in his lectures about supply and demand -- is that every transaction needs a buyer and seller. What makes the government think it will be any more successful in unloading the toxic paper than the private sector? I just don't see who is going to buy the stuff until there is a major turnaround in the housing market which may not happen for years. Even then, turning a profit will be a challenge.

American International Group Inc. (NYSE: AIG), which some are worried may be the next big financial company to fall, had planned to announce its turnaround plan on the 25th. Given the more than 40% decline in the stock over the past month, Wall Street decided it could not wait that long.

According to Bloomberg News, AIG may unveil a restructuring of the company before its self-imposed deadline. The story does not elaborate on this further. Investors are rightly concerned that ratings agencies may cut the debt ratings of the world's largest insurer triggering more than $13 billion in collateral calls that would drain its cash reserves further, according to Bloomberg News.

"The price of credit-default swaps, used as hedges against losses on bad debt, approached distressed levels and traded higher than those for Lehman Brothers Holdings Inc., the securities firm that's fighting for survival," according to the news service.

AIG, which has lost $18.5 billon over the past three quarters, raised more than $20 billion in capital in March. Kathleen Shaney of Gimme Credit told Dow Jones that AIG may have to sell assets in order to head off potentially ruinous debt downgrades.

Treasury Secretary Henry Paulson is steadfastly refusing to bailout Lehman Brothers Holdings Inc. (NYSE: LEH). That's not surprising given that its an election year and that the Democrats complained bitterly about the rescue of Bear Stearns. He shouldn't bail out AIG either. The companies got themselves in this mess. They need to get themselves out of it.

Another shoe is dropping in the ongoing credit collapse here in this nation of whiners. According to the New York Times, the default rate on so-called Leveraged Loans -- (a very strange name if you ask me since a loan is leverage) that refers to loans used to finance corporate takeovers -- climbed fast from 0.24% in August 2007 to 3.3% in August 2008.

The loans that have gone bad so far are not big ones -- they are more like the canary in the coal mine -- hinting at bigger problems to come. The Times says, "the loans that have gone bad have been concentrated in two industries - real estate and auto parts. S.& P. calculates that they have accounted for almost half of this year's defaults. Gambling has also had problems, as it turns out that there are too many casinos in some places."

The biggest loans have yet to default. But their collapse is inevitable. That's because banks are scrambling to raise capital and shore up their balance sheets. And the leveraged loans were structured to benefit from a lending market in which the name of the game was to keep from losing market share by making it ever easier to borrow. Thus the terms of leveraged loans were easy -- featuring, as the Times reported, a "flood of 'covenant-lite' and 'toggle-[Payment in Kind] PIK' loans."

The Washington Post reports that Hank Paulson plans to turn the back of his hand to people who hold common shares of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) in his "rescue" plan. But Paulson may bailout the holders of their preferred shares -- which currently pay a dividend yield of about 20%.

Why does Paulson prefer the preferred to the common shareholders? That's because the common shareholders are big mutual funds with lots of small shareholders who have no importance to the economy in his judgment. The preferred shareholders are regional banks whose capital he thinks would sink dangerously if he wipes out their dividend.

Below is a list from the Post of the big Fannie and Freddie preferred holders:

• Regions Financial (NYSE: RF) which has an estimated $200 million,
• M&T Bank (NYSE: MTB) with $161 million, and
• Astoria Financial Corp. (NYSE: AF) with $83 million.