Jeff Macke offers a good analysis of why the Treasury Secretary’s request for a $700,000,000,000 "bazooka" makes strategic sense, when you take psychology, behavior, politics, and incentives into account:
…$700 billion - a number that says "The government is going to take this entire problem down, all at once."
…[It] is intended to get guys like Warren Buffet to step in – guys who’ll be thinking, "No sense letting the government sop up the excess returns generated by holding these things to maturity; I’ll buy them myself, before the morons from Treasury get here."
…you give [Hank Paulson] a bazooka, rather than a BB gun, precisely because you don’t want him to have to shoot. A BB gun invites invasion. A bazooka makes a point.
…the difference between Congress going for the whole megillah or doing it in tranches is this: In tranches, every block that gets used up makes it less likely that another one is coming (because you gotta go back to Congress to beg some more). In effect, the government would eliminate a certain block of toxic assets but, in so doing, would make the rest of the group even more toxic (and therefore less likely to be backstopped by the government…).
…If the government does this in tranches, there will be literally no end to the outflow. If they do it in one, enormous, statement-making block, it’s possible the system will start running again.
Update 9/26/08: There’s another school of thought out there, which is that the promise of government assistance is actually contributing something to the credit market lockup. Markets are capable of resolving this crisis–the only reason a rescue plan is in the works is that many policymakers fear the acute economic fallout that would ensue. But private actors will not begin to move convincingly towards resolution as long as Congress (i.e., the U.S. taxpayer) is clearly in the picture.