Do read up on Arnold Kling before proceeding. From my outsider’s vantage point, it seems that commercial bank failures and consolidations are already being handled (see Alex’s recent posts) and of course the investment banks are gone. Money market funds are now (mostly) insured. I see three key questions for the next few weeks:
1. Will there be a run on hedge funds?
2. Will the commercial paper market dry up?
3. Will the Fed have to bail out any major foreign banks?
At this point, perhaps the Paulson plan is directed against these contingencies rather than being for the commercial banking sector per se. From this list, it is least clear how the Paulson plan would handle #2, although you could point to a short-run confidence effect. Will that last? #2 is the hardest to handle without implicitly socializing parts of the real economy and if you have good proposals for #2 please let us know. How much can corporations bypass the commercial paper market altogether?
"Recapitalization is a public good" is one key phrase for this crisis; "no natural buyers" is another. So far debate over the plan has focused on the first phrase but not the second.