Your economist friend is ignoring the role of credit derivatives. They are the 'monster in the marketplace' right now.
Your friend wants money that can be used in the market to create liquidity - there's nothing wrong with that, per se - unless:
Paulson trots out with his pail of money and pays too little for some of these mortgage bundles - or a LOT of these mortgage bundles.
Remember, Paulson won't have a clue WHAT to pay because of 'mark to market' regulations.
If he pays too little, then the cash flow of any underlying bonds associated with those mortgage securites could be interrupted to the point where the bonds go into default. This could, and would, trigger massive debt obligations in the credit derivatives market to those who 'insured' those bonds - investment banks, insurance companies, commercial banks, pension funds, etc., etc., etc.
This $700 billion of bailout money, spent in a haphazard way, will trigger trillions of debt obligations in credit derivatives, and make our problem much worse than it already is.
If the $700 billion is spent wisely, which it won't be (because it would take years to figure out the 'value' of the underlying mortgage securites on that large of a scale) then it is a matter of about 1 week before the credit markets begin seizing up again, because the credit derivatives market is 'eating' all liquidity in its path.
“SEC. 132. AUTHORITY TO SUSPEND MARK-TO-MARKET ACCOUNTING.
(a) AUTHORITY.—The Securities and Exchange Commission shall have the authority under the securities laws
(as such term is defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of
Statement Number 157 of the Financial Accounting
Standards Board for any issuer (as such term is defined
in section 3(a)(8) of such Act) or with respect to any class
or category of transaction if the Commission determines
that is necessary or appropriate in the public interest and
is consistent with the protection of investors. “