The trouble is - the economy needs liquidity at the consumer level and it's the banks who should provide that. If the Fed had the authority to knock on everyone's door and lend them money at 0-0.25%, it would do that. But sadly, the political class never creates regulations which force the banks to pass on the liquidity provided by the Fed - after all, that would leave the banks with less profits and lesser money still to donate to political campaigns.
As far as your comment on "let them all fail" - I disagree. For all the undeserved liquidity that the banks are currently enjoying, it is a far more benign evil than having all the banks fail - US Inc would probably still be firing 200,000 people every month instead of adding 100,000 (as it is doing now).
Perhaps. But when you leverage 100 to 1, fail, and the feds swoop in to avert disaster (the jury, of course, is still out on this), it's hard to say that it's just a normal day at the office. They spent/created huge amounts of capital that was necessary only because of the excessive (and stupid, even at the time) leverage of the financial industry.
Now don't get me wrong. I have a strong suspicion that Paulson is the most under-appreciated man in the world right now, literally. But we are all paying for an unnecessary excess, to keep failed institutions alive (save for poor Lehman. If it were only so easy as to just let them all fail). So I think the word "bailout" is apt.