Best- and worst-case economic scenarios

If mortgage rates keep moving lower, it should help some people refinance to avoid foreclosure while spurring sales by lowering the financial hurdle for people to buy homes. "I think this is a correct move. I think it will stabilize housing," says David Kelly, chief market strategist for JPMorgan Funds.

Stabilizing the housing market would be a confidence booster for the entire economy and the financial system. John Paulson of Paulson & Co., a $35 billion hedge fund that made a killing in 2007 betting against the U.S. subprime sector, told clients in a conference call days before the Treasury announcement that he's finally ready to make some tactical investments in financial firms that have gotten especially cheap, even though he thinks prices in the overall sector still have further to fall as foreclosures mount. His toe-dipping was first reported by the Financial Times.

If the housing market stopped sinking, or even rose, consumers might also spend more liberally, which would then boost employment and induce even more spending — the classic virtuous circle.

One optimist, James W. Paulsen (not to be confused with Henry or John), chief investment officer of Minneapolis-based Wells Capital Management, notes that the 94 percent of the economy that's not housing or autos has grown over 5 percent over the past year, while the 6 percent consisting of housing and autos has shrunk 20 percent. The implication, says Paulsen: "A quicker-than-expected turnaround is possible, since it would not require a broad-based recovery, but rather only a cessation of the collapse in two industries."

Signs of health in the U.S. economy would reduce the risk of a panicky pullout by foreign investors, ensuring that inflowing capital would help finance spending by American households and businesses. In fact, the dollar rose after the Treasury announcement, adding to a gain of 10 percent against six major currencies since mid-July.

The nightmare
So we're golden, right? Well, maybe not. In the vicious-circle scenario, Treasury's intervention ends up being a replay of Japan's ill-fated effort to prop up crippled banks in the 1990s. Increasing the availability of credit delays — but does not prevent — the full price decline needed to clear out the daunting overhang of nearly 4.7 million unsold existing homes as of July.

As the lender of last resort, the government throws good money after bad, first on housing and then on airlines, automakers, and other supplicants. All this against an undeniable backdrop of rising federal deficits: The Congressional Budget Office predicted this month that the federal budget deficit would remain above $400 billion annually from 2008 through 2010, up from about $160 billion in 2007.

In the nightmare scenario, the descent into quasi-socialism balloons the national debt and wrecks foreign investors' faith in the economy.

That's the vision sketched out by ultra-bears like Peter Schiff, president of Euro Pacific Capital, a brokerage in Darien, Conn. Schiff is passionate on the topic: "The dollar is going to go through the floor, interest rates are going to spike up, and we're going to have a complete financial meltdown. It's going to be the worst-case scenario."

A different school of pessimists says the housing market actually does need a big adrenaline shot from the government. But they say it's unlikely to get one from either a McCain or an Obama Administration because the risk to taxpayers from a much bigger commitment to housing would be deemed too great.

The only real beneficiaries of the takeover are the holders of Fannie and Freddie securities, who are bailed out of their bad investment choices, says Robert I. Kessler, CEO of Kessler Cos., a Denver investment firm. Says Kessler: "It's a great thing for the big banks. I don't see any benefit whatsoever to consumers."

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