But wasn’t the point to create a little deliberate ambiguity, so accepting a capital infusion wasn’t seen as a sign of weakness?

Truth is, it isn’t government’s job to create jobs, and by picking winners and handing out money, they are just trying to cheat economics – economics will win in the end despite government actions. So, IMHO, the government (despite what party is in power) has been going the wrong direction for a while.

The government (both Democrat and Republican) has been trying to get the consumer to take on more debts for a long time to give the illusion the economy is fine and dandy. An economy financed on debt will ultimately fail; It is unsustainable. Every time there is a hicup in the economy – they lower interest rates to entice consumers to take on more debt – which serves only to MASK the underlying problem with the economy – competitiveness. When lowered interest rates fail, the bail-outs and stimulus packages start to pop into the political agenda. None of these deal with the underlying situation – COMPETITIVENESS and Sustainability.

That said, whatever course of action is adopted, there are a lot of competing concerns that are in conflict, so whatever is done or not done will be bad on some counts. Here’s an incomplete list:

1) Cascading writedowns/defaults – the idea that failure of any institution causes a large markdown event for other institutions leading to further distressedp selling of assets and defaults – this seems to be the idea about why the Lehman failure had so many negative ramifications

2) Market failure of lending to non-financials – the idea that good risk borrowers are unable to get credit at reasonable rates, starving the economy and creating a further downward spiral

3) Failure of inter-bank lending – the idea that banks are not lending to each other at viable rates due to suspicions about insolvency of other financial institutions or internal short term liquidity emergencies

4) Generic Keynesian type problems in the economy – the idea that consumers and business are pulling back on spending too fast for the health and efficiency of the economy (I think of a Keynesian as basically someone who believes there is an emergent long term inefficiency caused by these sharply above or below trend short term expansion/contraction phenomena)

5) Mortgage/Housing specific problems – including the ideas that foreclosures are so inefficient that it is important to prevent them and that rate of home sales is a crucial macro variable with a high multiplier

6) Worries about the U.S. Federal debt and commitments

7) Worries about the financial health of municipal govts.

Worries about the value of the U.S. dollar and future inflation.

9) Worries about the moral hazard effect of bailouts

10) Worries about the fairness of favoring particular institutions and investors over others.

11) Worries about fairness to the U.S. taxpayer

12) Worries about the inefficiency of giving aid to badly run corporations.

Now, with respect the above list, one can talk somewhat simplistically about comparative benefits and harm of five policies at the margin: buying distressed assets from weak banks, buying distressed assets from strong banks, buying equity in weak banks, buying equity in strong banks, and doing nothing. I won’t take the time/space to go through the complete matrix, but here are a few points of rebuttal to the point of the piece above that it is better to help the weak banks: a) any bailout of a small bank is almost pure waste if the bank is still headed for insolvency shortly afterwards anyway, it is not helpful to issues 2), 4), and 5) if the result is a bank that only avoids insolvency by shutting down most lending, it is not helpful to 3) unless the cloud of worry is removed after the intervention, and it goes against issues 9) and 12). The counter argument is presumably that the better course is to inject enough equity into each weak bank to clearly make it a strong bank that has no incentive to hoard cash. But is it possible and practical to do that on a systemic basis?

I’ve read over and over about how Bernanke studied the Great Depression in detail and figured out how to avoid it. But if the key strategy depended on avoid a deflationary environment before it got started, perhaps it is already too late for that plan. In particular, conventional financial stimulus through financial entities probably doesn’t work well in an environment where cash is outperforming other investment/lending choices. Selling a lot of treasuries and then buying them back (or issuing them back) later at a cheaper price is a rather sensible strategy in such an environment (though exchanging them for worthless crap is not).