What Will It Take to Stabilize the Banks?

INTRODUCTION

There is considerable disagreement about how to handle the current severe financial crisis that has contributed mightily to the deep recession in which we find ourselves. Before we lay out our suggestions, it is important to underline a few ugly truths:

• No one knows the right answers with certainty. Although there are historical parallels for many aspects of the crisis, the combination is unprecedented. Answers that worked in the Depression, the Savings and Loan crisis, or Sweden in the 1990’s provide useful input, but there are dramatic differences between our situation now and each of those past crises.

• Every available solution is bad and the best we can do is to find the least ugly answer. A lot of culprits, both people and impersonal forces, dug this deep hole. We will have to pay a very high price to climb out again, a price we have already begun to pay.

• The pain is not even close to being over. How bad it gets depends on the economy’s path, as well as the solutions applied. Banks have not fully recognized the existing losses on their books and we know that the deepening recession will produce substantially more losses. Those additional losses will require still further aid from the taxpayers and will reduce the value of some of the investments taxpayers have already made.

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