The buzz on Capitol Hill is that Congress could pass an updated version of the bailout bill before the end of the week. But Shah Gilani in Money Morning says taxpayers are being “force-fed a political solution, instead of a sound economic market-based solution to a financial crisis.” He says the the bailout bill has eight key failings.

In plain English, here’s what’s wrong with the proposed plan and what alternatives should be immediately vetted and constituted into a new plan.

The Treasury plan was originally predicated on buying $700 billion of collateralized residential mortgage-backed securities that banks could not unload. The idea was that the banks would get the money, which they could then turn around and lend to keep the credit markets open and credit flowing throughout the economy. In the meantime, the Treasury Department would sit on the securities until it is able to sell them, hopefully at a profit.

The idea, from a theoretical standpoint, isn’t stupid. It is, however, impossible to implement to any degree that will result in its intended effect.

Here’s why:

1. There are more than $1 trillion worth of subprime collateralized mortgage-backed securities out there - and that’s just one type of problematic derivative security. The bottom line: $700 billion isn’t enough. Period.

2. The purchase plan is not limited to just residential mortgage-backed securities. Surprise! What else will Treasury buy?

3. Who’s going to fight off the lobbying groups out to influence the managers that the Treasury Department hires to direct money to their masters? Did we mention that $700 billion wasn’t enough?

4. The government plan is even more under-funded than people realize, for it doesn’t authorize the full $700 billion: Indeed, it starts with only $350 billion, leaving an even greater shortfall. Did we mention that $700 billion wasn’t enough?

5. Treasury is going to hire banking-industry managers to manage the process. Those managers are going to serve themselves - just as they served themselves to get us into the crisis.

6. There is no defined mechanism to determine what price the Treasury Department will pay for what it buys. For argument’s sake, even if Treasury were to only buy the problem securities its leadership speaks of in public - residential mortgage-backed securities - there are problems if it prices them too low: If that happens, some holders won’t sell them, taking the chance that if they hold them long enough they will be worth more than Treasury is willing to pay. How will those financial institutions regain liquidity if they won’t sell the securities needed to make this happen?

7. Since Treasury can’t buy all the problem securities, if it prices what it’s going to buy too low, all remaining holders will have to mark down their holdings and take more write-downs and losses. How will that create confidence and facilitate “liquidity”?

8. However, if the Treasury Department prices the securities too high, several problems quickly emerge: Hedge funds will rush to sell their current holdings, and may very well speculate by buying up more securities to sell them at a higher price (profit) to Treasury, meaning that the Treasury Department plan won’t necessarily be helping banks directly. What’s more, if those securities are priced too high, and the market for them continues to fall, taxpayers will eat the losses - a reality that likely will lead to an end to further program funding.

Shah says top of the list of solutions to the current mess should be the following:

1. Regulation.
2. The nature and existence of problem securities.
3. A means of accurately and transparently pricing those problem securities.
4. A cleanup of attendant problem instruments (credit default swaps) that are massively contributing to the problem and - in and of themselves - are sinking the U.S. economy.
5. The need to facilitate an accounting aide - short of eliminating mark-to-market accounting - by directly addressing how banks can still hold these problem securities and not have to incur unrealistic write-downs and losses.
6. A means of allowing problem securities to be used as collateral when borrowing from the Fed.
7. A method of helping homeowners directly.
8. A strategy that will support the housing market with sensible tax and capital gains policies.

Source: Heads I Win, Tails You Lose: Why the Senate Bailout Bill Will Fail Taxpayers