I've grown extremely frustrated by the rush to save our nation's banking system, because bad assets are not the real problem. Yes, some plans, such as the nebulous cloud of something that Geithner proposed, are indeed worse than others. But even nationalization will not itself trigger credit creation or lending. We're wasting precious time answering the wrong question.
Bernanke(whom I think very highly of, even when he screws up) stated this bluntly in his testimony today, though he's said it before. He said lending is -- my rough transcription -- "no longer frozen because of subprime mortgages and bad assets, but fear about where the economy is going."
This should be blatantly obvious, but everyone's missing it and arguing about who gets screwed. Meanwhile, loans are not being extended because it makes no economic sense to borrow or lend at current interest rates with current default risks. Here's a multiple choice question to illustrate.
You are an insolvent bank. The Treasury and Fed offer you virtually limitless amounts of liquidity at nearly zero interest rates, and even give you some cash for trash. You are now flush with excess reserves, even while securities trade in the secondary markets that bear record wide yields to Treasuries. You could receive 10% interest and expect 5% loss to defaults. Do you:
A) Hoard your cash as a poor man's loan loss reserve in anticipation of future defaults;
B) Lend your cash as fast as possible in hopes the spread will fill the hole in your balance sheet.
We know the banks' answer, so in the current economic environment, apparently the return proposition sucks. Now let's add that the Fed is buying securities outright to push down interest rates. You now receive a smaller spread, and also suspect there might be an outburst of inflation triggering the Fed to crank the FFR. Does your answer improve?
Nationalization and recapitalization don't make lending more appealing. Haggling over who has to eat the carcass is important in terms of loss distribution, but it has no chance of increasing credit creation or economic growth, because it does nothing to improve the fundamental economic realities of money creation. It's a horrible, useless distraction.
Until America becomes more competitive through real devaluation of some form, and the claims on debtors are lightened through bankruptcy, things will continue to deteriorate.