Beltway medicine men

NEW YORK (Fortune) -- The proposed bailout of the world's financial system isn't really about money, folks. It's about psychology. In fact, you can think of it as the most expensive piece of psychotherapy in the history of the world.

The idea is that having Uncle Sam buy tons of trashy, hard-to-value financial assets will change the psychology of lending institutions throughout the world. This financial Prozac, as it were, would cure the lenders of their fear and depression, encourage them to start lending again, and induce investors to pump new capital into these capital-short institutions.

But psychology - even when practiced by masters like Treasury Secretary Hank Paulson and Federal Reserve Board chairman Ben Bernanke - isn't an exact science.

That's why I wouldn't bet the farm on this bailout working as planned. How can I say that when some of the smartest investors in the land, like Warren Buffett and Bill Gross, shilled for the bailout plan?

Answer: Because Paulson and Bernanke have tried one thing after another to stimulate lending and restore confidence since the markets blew up in the summer of 2007, but nothing has worked for more than a brief period.

The two amigos had to ask Congress to fund the bailout, which comes directly from taxpayer money. But for the past 14 months they've thrown hundreds of billions of dollars of fed assets into the market, and lenders still won't lend. Recent figures show that the Fed has used recently created programs to put about $400 billion of cash and Treasury securities (which are the same as cash) into the credit markets, much of it as loans against hard-to-value securities. Despite that, debt markets are still glopped up (though things might be far worse, absent these programs).

What I find especially disturbing is that the Fed's post-Bear-Stearns-collapse program to lend to investment banks didn't forestall runs on investment banks, and Paulson's guarantee of Fannie Mae and Freddie Mac debt didn't settle those markets, forcing the Treasury to take the companies over. I thought both those programs would work.

It's going to take quite a while to see whether the debt markets' depression is lifted by the bailout - I wouldn't place much faith in early reports.

And let's not forget that there's a long-term psychological cost to this fix: It has enraged ordinary taxpayers-and rightly so. Don't be surprised if they lose faith in the supposed miracle of free markets, and in the financial system, and in the Fed and Treasury, which - unlike Washington pols - have been generally revered. That loss, in fact, may be the bailout's biggest cost of all.