Eric's excellent post illustrates a key point--it looks like Paulson has already given away the store before he even sits down to negotiate. He has already implied that the public interest requires buying up these mortgages for the good of the country, so (oversimplified) the sellers already know that Paulson is more desperate to buy the mortgages than they are to sell. So, ironically, it is now the sellers who have the upper-hand in fighting over the valuation of the paper they hold.

Not to mention the apparent "lemons" problem--presumably there is an information asymmetry here such that current holders have more information about the value of these securities than the Treasury. Which means that with respect to paper that is overvalued, the banks will sell. With respect to paper that is undervalued, the banks can keep it and resell it to someone else.

This all reminds me of the old banking adage: "When you owe $100,000 the bank owns you. When you owe $100 million, you own the bank."

But what if you owe the bank $100 billion? And the bank is the Federal Reserve?