Over the course of the week, the stock market dropped by a thousand points, and then rallied for a thousand points on news of the government bailout. "But underneath the surface, credit markets and capital markets were freezing up. And when the capital markets freeze up, then mainstream American companies have trouble raising money to do their job; farmers will have trouble getting loans, small business people will have trouble getting loans. This would then hurt the broader economy," Paulson said.
"This was a situation that we couldn't allow to go on."
The chain reaction had its roots, Paulson said, in irresponsible behavior and lending practices, and from people borrowing money when they shouldn't have. The illiquidity that resulted meant financial institutions could not function.
Appearing on CBS News' Face The Nation, Paulson said the $700 billion plan was the "least costly" option.
"We felt this was the best way to stabilize the situation, unclog the system so that it can work."
"I hate the fact that the taxpayer is going to be at risk, but the taxpayer was already at risk. And I think this is going to minimize the cost to the taxpayer. "
Host Bob Schieffer noted that the figures being discussed for the bailout are higher than what the United States has spent on the Iraq War.
But Paulson was quick to differentiate between money tied to Iraq and the costs associated with the administration plan to purchase bad debt.
"The Iraq war was expenditures," Paulson said. "This is purchasing assets, holding assets, reselling assets, with money coming back into the Treasury. The taxpayer is clearly at risk, but … this, I think, will minimize the risk and the cost to the taxpayer."
"We as a people always work through these situations. We will work through this situation. The markets will stabilize over time and then we will do what we need to do to clean up the mess."
But the costs of the program augur a tremendous jump in the budget deficit. How will the incoming administration handle that?
"Well, the next president is going to have some challenges," Paulson said, "and there's no doubt that debt issuance by the United States of America is going to go up. I'm not minimizing it at all, but I want to continually emphasize, because sometimes people get confused, this is different than spending money you know you're never going to get back; this is buying assets, holding assets and then selling assets. And although I can't tell people now what the cost of that process will be, and there is a risk, the ultimate cost will be determined by how quickly the economy is stabilized and what happens in the housing markets."
"Are you asking other foreign governments to help as well?" Schieffer asked.
"We have, we are urging others to do so. A number have expressed willingness to do so. This is, you know, a global financial system. I'm not saying anyone is committed to do this yet, but … we've started that dialogue."
But will the final plan that Congress approves be limited to giving money to banks, or will homeowners or others hard-hit by the financial crisis be included?
"We're on track to lose over a million private sector jobs this year, and this [crisis] is going to exacerbate an already bad situation."
Another concern was executive compensation for officers of companies who are being bailed out. "It would be a grave mistake to say that we're going to buy up the bad debt that resulted from the bad decisions of these [private sector] people and then allow them to get millions of dollars on the way out. The American people don't want that to happen and it shouldn't happen."
Frank said Congress wants to add measures that would slow down the number of foreclosures. "It's kind of hard to tell the average American that we're going to continue to have foreclosures that destabilize neighborhoods and deprive cities of revenues they need, but we're going to buy up the bad paper."
"We don't know the endgame in this. And I'll tell you what bothers me about this: that I believe that the chairman of the Fed and the Treasury Secretary Paulson, with all due respect to them, they've been staggering from crisis to crisis and they haven't even said today that this will end the crisis. He said this will lubricate the financial markets if we take the financial sludge, as we call it, off the books of the banks. But as Congressman Frank said, this doesn't do anything for the homeowner. This is doing something for the banks. And if [homeowners] get any relief, it'd be incidental."
Frank said the amount of debt that the government would take on strengthens his argument for a surtax on the wealthiest Americans - those who made the mistakes in the financial market, or who profited handsomely from them at the expense of the system. "It's almost as if we let them take the economy hostage by not having appropriate financial regulation.
"I agree with the secretary, it's not going to ultimately cost all these hundreds of billions - we'll recover most of it, maybe all of it - but I do think at this point the people making over $1 million a year, a surtax on their incomes, that's one way to get the people who made these mistakes to contribute to the cost of undoing it. But I do stress, I'm speaking only for myself here."
Shelby ("I'm not a taxer") said that the burden on the taxpayer is unavoidable. "When we add an additional trillion dollars to the debt … sooner or later there's got to be a reckoning, as you allude to. And I don't know what's going to happen. But I can tell you, you add a trillion here and a trillion there, and you've got a lot more debt on the American people, and that's what I'm concerned about.
"We've been down this road before, through the thrift bailout. [It] cost the American taxpayer billions of dollars. This is the mother of all bailouts and we don't see the end in it yet."
Read the full "Face the Nation" transcript here.
By CBSNews.com producer David Morgan.