It's a multifaceted issue and the simple truth is that nobody really knows how bad things can get. Japan has never really recovered. One of the underlying problems here is that a huge % of the mess is tied to what I consider artificial investment vehicles not the true underlying assets. Not all of these are mortgage based. AIG had huge positions in derivatives based on unsecured consumer credit.
The crisis has triggered the collapse of a number of investment banks but also endangers the underlying banking framework. If we think of the bank as a bookie who basically is taking bets on America we get a simple picture. The bank takes wagers (lends you money) and spreads the return to both its shareholders (dividends) and customers (interest on various investment vehicles. Basically the mainstream banking system acts as a money pump that recycles both wages and savings into the economy. To a large degree the economy relies on "lubrication" {the availability of funds} in combination with the "customers" {consumer or commercial} willingness to purchase.
One main indicator of the true cost of money is the LIBOR (London Interbank Offered Rate) which has just about doubled. The flip side is that we actually have roughly 290 Billion $$$ available at any moment for a bank to lend. So the truth is that the capital is already there and the bailout doesnt really touch on the underlying issue. What it does touch on is confidence, if people wont spend (or cant), banks wont lend and things actually grind to a halt we can be in a true depression in less then a year. This is regardless of the "bail out", personally the big problem is the very people responsible for the solution are at the heart of the problem IMO.
I think that as a nation we'd be much better of letting the dust settle and everything thats going to fail just go under and pick the pieces back up. You can't build a strong structure on a bad foundation. The other issue is in seperating out the paper instruments from the underlying assets. Some of these things have underlying intrinsic value and others don't. What Paulson will do is buy the junk and let the banks keep anything that has true value. The opposite is whats required, right off the losses and build on the value.
So the simple answer is yes, it is potentially a catastrophic failure at the system level that will put the United States back in the financial stone age by 2011 and leave us a 2nd tier economic power. However the current bailout will have absolutely zero effect on this either way. What it will do is mitigate a lot of the losses suffered by those who bet on certain market factors at the wrong time...but the simple truth is that the cow left the barn and the underlying asset is toast (or was fictional to start with). So all your doing is giving those individuals a "re-do". Remember that every one of these now over-priced homes was actually sold and that the money spent was real and is elsewhere in the economy. So a $500,000 house is now worth $400,000...well the $500k got put somewhere it didnt get burned. The current house can be discounted to 300k and a 200k loss is incurred for the "owner"....so be it. Who says you can't have a loss.
The problem is that buying the derivative doesnt mitigate the actual loss and doesnt effect the underlying problem above. Until someone will actually buy the house and the bank will write a new loan you cant raise the value of the actual asset. Now if you create a convertible lease/purchase note that allowed a buyer to lease a home and then convert to a 30 yr note at the current 30 yr T-bill rate (4.17% at the moment) you'd stabalize the underlying asset...regardless of who owns it while giving a reasonable return to the owner of the note, backed by the US government which also has an underlying asset. So the house has a new value, the note holder gets something, the seller has supposedly pumped his windfall back somewhere and the system slowly recovers...
