Paul Krugman thinks the Paulson-Obama bill should probably be passed:

I’d rather see Dodd-Frank-Paulson, which is much better than the original plan, pass than not. The true cost to taxpayers will probably be close to zero, and it would buy some time. But I’m not passionate about this. The real financial rescue still lies in the future, probably under the Obama administration.

Krugman is assuming two things:

1) This is a downturn which will correct itself in the next few years at which point in time the paper that the Treasury buys will return to full value or at least more than they were bought for. Since it will have been bought at a discount, that means the government will make a profit.

2) That Treasury will act competently and with an eye to making a profit and as such will not pay more than the value they can eventually get.

If you believe any of:

1) That the paper will not return high enough to recoup losses, since Treasury will be buying it at above market value;

2) That this is the beginning of more than a normal recession;

3) That Paulson in particular and Treasury in general will not make getting the money back a priority, but instead make their priority overpaying the banks to help them;

4) That because of information asymmetries, as Soros has explained, the Treasury is going to get stiffed with the worst crap;

then you don’t come to the same conclusion as Krugman does. Krugman, fundamentally, as he says himself in the article, believes that these people are operating in good faith and that they are not actually incompetent. Krugman is, as it were, extending them the benefit of the doubt.

Given the track record of the Bush administration, I would respectfully submit that extending them the benefit of the doubt is not wise. In fact it might be considered the opposite of wise. Remember also that we are talking about the Bush administration, the 700 billion can be all spent by the time Obama gets into power, and it probably will be.

Krugman praised Bernanke when he was appointed and extended him a ton of benefit of the doubt. He was wrong to do so. There are few economists I respect more than Krugman, but he is still an insider who believes that other people who are part of the club are to be granted the assumption that they are both competent and operating in good faith. Since Bernanke has turned out to be a disaster, and since Paulson’s track record is abysmal, I will submit that Krugman is wrong to think this.

As such, he is also very probably wrong to assume that the bailout bill will probably do no real harm and have no real cost.