I think the theory of the long-planned bailout our good, and extremely trustworthy, friends in the Village are preparing us for is this:

The Village Theory: The toxic paper is, ultimately, pyramidded on top of mortgage lending, and that the financial slicing and dicing, and all the "complex" instruments, and all the "innovation," have managed to obscure the true value of these mortgages from the market, and that when the situation stabilizes -- thanks to forking over big wads of cash to Hank Paulson's golfing buddies out of his trillion dollar slush fund -- the market will realize that the mortgages really are worth more than they are today, so some (most?) of the trillion will ultimately be recovered. (As Krugman remarks, a trillion dollars seems like a lot to pay for price discovery, especially when the markets are supposed to do that anyhow for nothing other than transaction costs.)

But is The Village Theory even plausible, let alone true? Set aside the faux populist idea the problem is executive compensation, a minuscule number beside the trillion; set aside the idea that a lot of that trillion will go to pay for fraud and thievery, which it will; will the plan, if it's based on The Village Theory, work? (That is, if "work" be defined as anything other than handing Hank's buddies more loot, and I'm not sure it is.)

I'd argue that The Village Theory is not plausible. The real source of the crisis is that the market is valuing the mortgages correctly (or more correctly than not) and that's what caused all the paper to turn toxic. Why the loss of confidence? Because a confidence game is at an end. Why? Forget the cheesy construction practices and vinyl-covered styrofoam pediments. The key: All the new housing that was built during the bubble was architected and organized as suburban sprawl. But suburban sprawl is based on oil in every way -- for transportation, for heating and cooling, for everything. And the cheap oil that the Iraq war was meant to seize isn't happening.*

Now, everybody knows, deep inside, that suburban sprawl isn't sustainable. But losing the Iraq War's oil means that suburban sprawl isn't sustainable now.**

That, in turn, means that other things being equal, people would rather not live in the suburbs, and would rather live in locations (cities) where their energy footprints are smaller.

That, in turn, means that the mortgages for all the suburban houses built during the bubble are worth less now then they were, and that prices will not "recover."

Therefore, the solution is not to hand Hank Paulson and The Village a trillion to "create our own reality" [again] but to accept the reality these mortgages are worth less and solve both the homeowners' problem and the toxicity problem via HOlC: a "cram down" that brings the mortgages into line with the real value of homes, lets homeowners get well on their payments, and cleans up the balance sheets of the banks, as well.

But, no, "we" can't do that. We have to hand out a trillion to Hank's buddies, and a bunch of consultants and asset managers, and try to keep the confidence game going for one more round.

Having bet, and lost, on cheap oil from Iraq, the Village now -- in the mother of all doubledowns -- is betting a trillion dollars of your money, and your future, on the bailout.

The bailout will fail.

And in failing, it will piss away a large part of a trillion dollars, because the market is right and these homes really are worth less. However, the Village will be happy, and Hank's posse will be happy, and all the serious people will be happy, and all the little people will be totally fucked by the shock doctrine austerity measures that McObama will implement to deal with the crisis that comes when the fail becomes evident. What's not to like?

Well done, all. Will there be ponies? I wanted a pony.

NOTE * Absent a huge strike in the Arctic and the subsequent invasion Conservative-led "voluntary integration" of Canada.

NOTE ** That is why gentrification will push the poor out into the burbs, from where public transportation will take them into the cities for work, or would, if only we handled spent the trillion dollars bailing out Wall Street.

NOTE For the big, big picture, see Stirling Newberry here.

NOTE I realize that the bailout is now being marketed as a "recovery plan," but that's just the usual load of crap that the stenographers in our famously free press have decided to, er, recycle.

UPDATE Latest from RGE Monitor.

UPDATE It may be that the Ds have muscled in. If so, for once, I may have been too cynical. We'll see!