If a repo-counterparty fails (just like Lehman did), the fed owns the crap for good and can mark it down at whatever pace it chooses to amortize it, in proven mark-to-model fashion. They could even have an operating loss, it's only a technicality (the Bank of Japan did a few years ago during the quantitative easing policy).

I believe more in the explanation that it saves the investment banks because assets will be bought at a higher price than what they have already marked down (so they have a profit in their accounts).

No-oversight provisions also allow Paulson & al. to run away to the bahamas with lots of cash. Paulson probably still owns lots of share from its alma mater Goldman Sachs.

Regarding inflationary measures, we are in it already: the fed was short of 50% of the money it lent to AIG, had to have the treasury issue new debt to put it on the FED asset side of balance sheet. They are now officially printing (in M1 aggregate), since one week.

But that won't stop the deflation in assets: their total value is not commensurable to M1, and won't be before years and years of printing. It is more a function of debt outstanding, which is a multiple of the fed balanche sheet by virtue of fractional reserves at the secondary banks. Now that risk aversion brings the multiplier down (reserve ratio go up de facto because of loss provisions), debt will deflate no matter the printing.

Well, at least in the beginning...
If printing overshoots, it will be Zimbabwe. But I think we are still many years away from that.

In the meantime, consumer products & gas (both mostly imported) will inflate strongly all along because of dollar exchange rate losses.

Pierre