Reply #7: The problem is that MBS are not really backed by anything at all.

[bemildred]

They are based on a bet that the vast majority of the bundled mortgages will perform, that the number of defaults will be "small". So they lost their bets, because in fact home values were inflated, and prices have tanked, and too many mortgages are "not performing". So they lost their bet. What happens in Las Vegas when you lose your bet?

The "bailout plan" is based on another bet, that eventually most of the mortgages will recover, begin to "perform" again, that eventually housing prices will "catch up" and let those mortgages "cash out". So built into this new bet is the expectation of re-inflation of housing prices. This masks the losses associated with the bad bets with loss of value through price inflation and its converse dollar deflation.