First, the Treasury will NOT be buying all fake Vermeers and real ones. It will be buying about 5% of them. Anyone who knows that they have a velvet Elvis will sell it to them. So they are llikely to end up with mostly Elvises. Because the sellers will be dumping their known bad assets first, they will depress prices. To the extent that they get away with it, they could actually depress prices for assets that ARE valuable.

Second, the banks will sit on 95% of the paintings after all this is over. If the Treasury does no more than buy at a price it thinks reasonable, then that will not achieve squat, as it does not form a basis for a re-evaluation of these paintings. After the bailout, the banks have not had a price discovery process, and so are in the same spot they were before. Minus 5%. If the selling process ends up depressing prices further (by making it look like there are more Elvises in each asset class than is really the case), they may be worse off. A lot worse…

The problem is that an illiquid instrument that depends on the health of the global economy as well as microscopic factors (the exact houses that form the collateral) can not be made liquid unless everyone agrees on a valuation model. Banks cannot agree on the valuation model anymore, and there may actually not be a reasonable model for the current economic circumstances. There is nothing Paulson can do about that. Or anyone else.