The NY Times has a good summary on the rumors and where they originated. An interesting theory on why Google might want to get into the online payment business appeared in a discussion thread on WebmasterWorld. Google has lots of experience managing small amounts of money through its adWords pay per click services. Extending this infrastructure with payment functionality would be a micropayment infrastructure many envisioned a couple years back as the future revenue of online publishers. Well micropayments did not happen yet. It only can be found in niche areas. Google with its ubiquity could maybe pull it off.
Just another PayPal might even for Google not successful. Several companies tried in the past and failed to challenge PayPal.