And who is to blame? Paulson for one. It seems like he can’t get out of his Investment banker mode. Say… Goldman has bad assets and can’t lend? I’ll fix that, just buy em from GS. That’s not going to pass muster? I’ll give em a cheap loan.

Bernanke in my view is doing the right thing. I believe that you David have published about the Fed’s balance sheet, surely you have noticed the extra $600Bln of slime that appeared in the September to October time frame? The Fed absorbed in 30 days almost enough assets to match the entire Paulson plan, or at least Paulson I. So I conclude that BB is both flexible and accomplished what he wanted without the fanfare.

I think what you are suggesting is that there is an absence of leadership in Washington. No argument from me. Paulson clearly lacks vision and political savvy. Bush is AWOL again. I would like to point out the last major bank crisis, the S&L crisis of the late 80s, required leadership from both the congress and the executive branch. Volcker did not emerge one day, and rip open his shirt to reveal a big “S” on his unitard. Cut Bernanke some slack. He clearly doesn’t have the leadership skills of a Volcker, which is unfortunate, but he is bright and creative, and god knows where we would be right now without some very skillful and deft improvisation from the Fed.

What would your policy prescriptions be at this point?

Terry,

“They should do this in a way that doesn’t undermine healthy commercial banks (such as PNC), but enables taxpayer money to actually reach those in the private sector who need it…”

I can’t see how the government could compete with commercial banks directly without undermining the healthy ones. I think the problem with expecting banks to lend more in this environment is that the interest rates banks are allowed to charge may not be high enough to compensate them for the risk they’d be taking on. Perhaps there are other ways the government could increase liquidity in the real economy, perhaps by channeling funds through non-traditional lenders.

As a result, I think the policy idea of injecting capital or buying bad debts or lending to endangered banks & insurance companies is doomed to fail in creating liquidity. The deleveraging requirement is far larger than the government’s ability to absorb those losses while increasing liquidity through the banks. I think some of the financials are too big to RESCUE.

I have been thinking about an alternative approach, which is probably full of holes, but may be worth considering (if smart people can figure out how to fill the holes). It entails two steps:

1. The US and other governments stop providing any financial support to financial institutions that are suffering because of their overzealous use of highly-leveraged securitization. So, it would be OK to help PNC take over NCC as has just occurred, but no more funds would go to the Wall Street crew.

2. Have the Fed and Treasury assume the normal business functions of banks, dealing directly with the private sector. The could provide credit, take in deposits, and do things that normal banks do using their balance sheets and the balance of the $700B Congress has allowed Treasury to spend. They should do this in a way that doesn’t undermine healthy commercial banks (such as PNC), but enables taxpayer money to actually reach those in the private sector who need it (businesses and consumers) and, thus, keep the “real” economy moving (if not thriving). The Fed’s new CPFF is probably hte first such step in this direction. Certainly there are enough laid off private sector banking types to staff USG efforts.

The key consequence is that the highly leveraged banks would eat up each other. A few would survive in a much diminished capacity. As they deleverage, they would be permitted to participate in regular commercial banking operations (if they could), but they would be banned from securitizing assets. In short, they would be forced to act like a bank, not a Ponzi scheme.

The point of this exercise is that it is more important to save the economy with the limited resources the USG & other governments have available than it is to save the major banks and insurance companies (and GE, GM (GMAC), etc). Moreover, I suspect that there is a better chance for the taxpayers would see their money returned than dumping into the black hole of bank balance sheets.

At some point, the USG would ease out of its role as the financial sector is able to do without the extra involvement. My guess is that the way to do this would involve raising loan interest rates while lowering them on deposits so commercial banks look more attractive. Certainly there must be other ways as well.

I can feel the breeze of Keynes spinning in his grave. But I’m certain that throwing more money at banks in any form will NOT lead us out of this financial crisis and deep recession.

I would welcome thoughtful comments on this by anyone.