The bailout doesn’t address massive bad debt.

When J.P. Morgan took over Washington Mutual last week, chief James Dimon presented an extremely negative appraisal of Washington Mutual's loans, predicting that the "friendly bank's" loan portfolio would experience 20 percent losses—a number pretty much unprecedented by postwar standards. So far, however, we have yet to see an appraisal by a banking chief that is negative enough. The credit markets have been beaten over the head with the basic principle that whatever the estimates are, the reality will be worse. When it comes to hundreds of billions of dollars of the wink-nudge "We don't care how you'll repay loans" made by Washington Mutual, Countrywide, and, to a lesser extent, Wells Fargo and other banks, there is every reason to think that virtually every one of the loans will go bad. Nor does the situation look promising for asset-backed securities (bundles of consumer debt tied to credit cards and auto loans) or for the financial institutions that hold them.

The underlying problem of bad debt is one that the bailout barely addresses. In fairness to the creators of the bailout bill, that's because, for the most part, it can't. The government could do some things to make it easier for debtors to repay at least part of the bad loans, like renegotiating terms, but the basic fact—loans that should not have been made were given to people and companies that should not have taken them—is out of federal hands.

One consequence is that the bailout could wind up costing the taxpayers even more than the astronomical numbers that have been bandied about. Some policymakers hope that when the credit situation eases, many of the bonds that the markets now consider to be nearly worthless will turn out to have more residual value as the market becomes more rational. Unfortunately, it's also possible that the markets are a lot closer to setting the right value on all this bad debt than we'd like.

That means the government might recover little of its guarantees. It means that the biggest financial companies will continue announcing losses far into the future. But, worst of all, it could also mean that the credit markets will have a decreased appetite for risk for a long time. The flight to safety can last not a matter of days or weeks or months but indefinitely. For an economy that has become used to the easy availability of credit, this has dramatic consequences. The aim of the bailout bill, in the simplest terms, is to restore lenders' confidence in the world economy and in financial institutions. Unfortunately, it's hard to restore confidence when U.S. financial institutions have given the markets so many compelling and intractable reasons to lose it.

(Photograph of a brown bear by ALEXANDER NEMENOV/AFP/Getty Images)