When a bank is insolvent, it doesn't have enough capital to cover its losses. In that situation, banks wd be doing the RIGHT thing by keeping the bailout money that we're giving them -- not loaning it out. An insolvent bank needs to hold onto their capital because that's how they fix their balance sheets. If they loaned the money out, they'd be in danger of returning to the very situation we're trying to rescue them from

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The news about banks has gotten kind of confusing.   If you turn on The Today Show at random, you can find yourself listening to something like this, from the chairman of the FDIC:

"As of this date, all these large banks exceed regulatory standards for being well capitalized.   So for right now they're fine...

But then you accidentally flip over to CNBC and hear this:

"With regard to so many of these banks, the stocks are telling us that their underlying equity value is zero, or maybe just a little bit above zero."

And then someone from the Obama Administration (whose very jobs depend on us understanding what they're trying to do to try and fix the economy, who are actually trying to explain this stuff to us) will say something like this:

"Those institutions that need additional capital will be able to access a new funding mechanism that uses capital from the treasury as a bridge to private capital."

Finally, here's Treasury Secretary Tim Geithner on Capitol Hill explaining his plan to fix our banking system:

"The capital will come with conditions to help ensure that every dollar of taxpayer assistance is being used to generate a level of lending greater than what would have been possible in the absence of government support.   And this assistance will come with terms."

So what does all this mean?  

Compared to what it once was, the stock market is way down.   Experts say it will soon be dropping again.   Banks aren't lending the way they used to, even though our government has given them billions of dollars of our money to help them start lending again.   And my life, your life, the entire economic fate of our country, and the world for the next decade, depends on whether or not the United States can fix its banking system.  

What follows next is a simple explanation of everything you need to know to understand the U.S. Banking system and how it might, or might not be fixed.   This summary explanation is based on a program  I recently heard on public radio, the printed transcript of which is available online.

If you want to understand this banking crisis, you need to understand one simple thing first.   And for some reason this is something that the mainstream media and schools K-12 across the country ignore -- and that is the nature of a bank balance sheet.   If you are fairly familiar with banks and bank balance sheets, skip ahead.   Otherwise, read this introduction first.

Let's begin by imagining the simplest bank in the world.   Call it Bobby's Bank.

Bobby is 11 years old and in his new bank he has invested 10 dollars of his own money that he's using to start his bank.   He goes to his friend Alex and says, "Hey, Alex, do you want to open a savings deposit with my bank?   I'll give you 3 percent interest each year."

Alex says that sounds great, and actually has 90 dollars right at hand to invest.

Banker Bobby then says to himself, "So now I have 100 dollars in my bank, 10 of which is mine, 90 I got from Alex.   All right, so now I need to make some profit.   And that requires at least one other person.

Along comes Caitlin, who says:   "I need to borrow 100 bucks, to buy a doll house."

Banker Bobby quickly replies:    I'll give you the 100 bucks in my bank, but on one condition.   You have to pay me back at a higher interest rate than what I'm paying Alex.   That way I can make some money.   So, let's say you pay 6% interest.

Caitlin agrees and the 100 changes hands.

Banker Bobby marvels to himself, "I'm in business.   This is great.   I'm getting 6% from Caitlin.   I pay 3% to Alex, and I get to keep the difference.   Now let me get some more depositors and some more borrowers."

At a fundamental level, banking is really this simple.   You pay your depositors a low rate, and then you lend out money at a higher rate, and you keep the difference.  

So with that preparation, let's now look at the world's simplest bank balance sheet.  

Picture a piece of paper with a line drawn down the middle.   On the right side is Banker Bobby's ten dollars, the ten bucks that he started the bank with, plus the 90 bucks he got from Alex.   On the left side ...   is the 100 bucks he gave to Caitlin.   If you notice, both sides are equal.   Ninety plus ten on the right side, equals a hundred on the left side.   And that's why they call it a balance sheet.   Both sides have to balance.

Ok, now some jargon, to prepare us for real banking.   Banker Bobby's ten dollars?   That's called the bank's capital.   The people that own the bank own that.   And when Banker Bobby makes his profit every year -- you know the difference between what he's getting from Caitlin, and what he's giving to depositor Alex, that profit is added to the capital on the right side of the sheet, that the bank owns.

So year over year, if the bank is well run, the capital gets bigger and Banker Bobby gets richer.   But now the jargon gets completely confusing and backwards because most of us aren't used to thinking like a bank:   The 90 bucks that Alex deposited in Banker Bobby's bank, also has a name, and it's called liabilities."   To Alex of course, it's not liability, it's a deposit, it's his savings, but to Banker Bobby it's a liability.   Why?   Because he owes Alex that 90 bucks, he's liable to Alex for that money.   Alex can withdraw it at any time and Banker Bobby needs to pay Alex interest on it.   To Banker Bobby, it's like a loan Alex gave him.

So now let's gently introduce another piece of jargon... That 100 bucks that Banker Bobby gave to Caitlin?   That's called an "asset."   Caitlin has to pay Banker Bobby some money every month and within 3 years has to pay the entire 100 bucks back, plus 6% interest every year on the amount of the loan that remains outstanding, i.e. on the amount of the loan she hasn't yet paid back, which is referred to as "the principal."  

So, when Banker Bobby thinks of Caitlin's dollhouse mortgage, he thinks of it like an investment.   He gave Caitlin 100 bucks up front, and she's supposed to pay him back 6% on the principal each year for 3 years, or for however long the dollhouse mortgage is agreed to last.   That is Banker Bobby's asset, because Caitlin is legally and financially obliged to pay him that nice return.   And if he wants to, he, Banker Bobby, can sell that asset to someone else, who then has the legal right to collect those agreed upon payments from Caitlin, for the life of the loan.   This is known as selling a debt instrument or just selling debt, or selling a mortgage.

The point to be understood here is that every bank balance sheet looks this way.   On the left side you have assets, and on the right side you have liabilities plus capital.   And they always balance out. And this is true from this very simple hypothetical children's bank in a world with one depositor and one dollhouse, right up to the largest and most complicated bank that has ever existed, Citibank whose balance sheet we will now take a look at.

First it says what they have in the way of assets.   Instead of 100 dollars in assets, they have 1.95 trillion dollars in assets.      

On the other side of the balance sheet, liabilities, 1.8 trillion and capital of 150 billion.   Notice that these two sums equal 1.95 trillion.   Once again, it all adds up.   Assets equal liabilities plus capital.   Both sides of the balance sheet are in balance.

So, here's where things get interesting.   And here's why we had to make sure you understood bank balance sheets first.

Caitlin comes to Banker Bob and says,   "I can't pay my mortgage.   I lost my job.   So that money I owe you, it's not coming."

Banker Bob's reaction is sure and swift:   "I'm going to kick out the tenants and take the dollhouse."

So now Bob's bank owns Caitlin's house and he needs to sell it, to get his money back.   But it's a down market in dollhouses.   And all the dollhouses out there just like Caitlin's are only selling for 95 dollars, which is a problem for Banker Bob's balance sheet.   Because, now it looks like this:   Liabilities, 90 that he has but that he also owes Alex, and 10 of his own dollars, equals 100.   Assets, on the other side of the balance sheet:   one dollhouse, worth 95 bucks.   Banker Bobby's balance sheet is out of balance. And the only way to correct it is by acknowledging, and then recording the fact, that his 10 dollars in capital has been transformed into 5 dollars in capital.

Having lost 50% of his investment, Bobby now has only five dollars in capital, which is all that remains of Bobby's initial investment of 10 dollars.   So both sides equal 95, they're back in balance, but Banker Bob has lost five dollars.   The important point here is that there was no other way to make the balance sheet balance:   Bobby had to take a hit.   That 90 dollars of Alex's money isn't going to change because if he wants to withdraw it, Banker Bob has to be able to hand him the 90 bucks -- at a moment's notice.   So the only thing that can change is Bob's capital, i.e. the 10 dollars of Bob's own money that he started out with.   To reiterate, he's lost half his money.   And this situation he's in with Caitlin, this is the situation a lot of our biggest banks are in right now.   They've lost at least half their investment money because the value of housing has fallen precipitously.  

And instead of one Caitlin, there are millions of them.   They all bought "dollhouses' at the height of a doll house mania.   And dollhouses have lost not 5% of their value, but 10, 20, sometimes 50% of their value, depending on where they are located.   They've gone from being 'assets' ...   to 'toxic assets.'   But unlike Bobby, the big banks don't want to admit this.   They want to keep it a secret how much they own in the way of toxic assets.   Because if the full truth were widely known, they might very well be forced out of business.

Let's go back to Bobby's Bank and Caitlin's doll house for a minute.   Let's say the doll house becomes a VERY toxic asset, because it's market value drops by as much as, say, 50%.   If Bobby's bank takes over Caitlin's dollhouse, and he can sell it for only half of it's original value, then Bobby's balance sheet looks very bad indeed.   Why?   Because a 50-dollar loss on the left side of the balance sheet, has to be matched or balanced on the right side of the sheet.   In other words, Bobby's original 10 dollar investment, his capital, is totally gone.   But not just that:   40 dollars of Alex's 90-dollar deposit are also gone.

So, not only is Bobby's Bank wiped out, but also he can't even pay back his creditor.   Depositor Alex loses half his savings and Bobby loses his bank.   And it's all because of Caitlin and her stupid dollhouse?

But wait, there might be a way out.

Banker Bob says, "I don't want this disaster to happen, and so I came up with a plan:   I'm not going to sell Caitlin's dollhouse.

To that, depositor Alex fumes:   But what about my money?   It's only worth half of what she paid for it, but you have to sell it, because I have to at least get some part of my deposit back!

Banker Bob's reply:   Alex, don't worry about it.   Your money is still totally safe in my bank.   Why?   Because, I know the dollhouse market is coming back.   Just keep the faith in that.   It's got to come back.   And that means that all I have to do is keep Caitlin's dollhouse on my balance sheet, listing it as more or less worth its original value, and that allows me to make a simple claim:   The market for dollhouses is "illiquid' right now;   in other words, I am not able to sell the dollhouse, into this market, so there's no way, really, to determine its market price.   So we're fine -- we just have to assume that the market is going to come back, and that I will eventually be able to sell it for a hundred bucks, a ways further down the road.   In the mean time we keep our books hidden and don't talk about what's really on them or in them.   Keep the faith Alex.  

However, depositor Alex is wholly unsatisfied with this, and says, "But that's a crazy assumption.   We're entering maybe the worst recession in decades.   People are losing jobs and income all over the place.   Everyone says things are probably going to get worse in the short term, not better!

Banker Bob's response:   Shhhh!   Alex, I've chosen to believe that this house will be worth more one day.   And it's important that you share this faith.   If we and our government can just keep assuming that the dollhouse hasn't really gone down in its ultimate value, then everything is okay.   (Otherwise I'm going to lose my bank and all my money, and so are millions of other people.   So for the time being, it's imperative that we all pretend that everything is okay.   So don't upset the apple cart.   Don't rock the boat.)

Depositor Alex replies, "That's funny, I talked to a professor at Columbia Business School yesterday.   He's an expert in bank crises and a former banker himself.   David Beim's his name.   And he told me you'd say exactly that."

Note:   In the real world, bankers are saying much the same thing as Banker Bob.   They too hold toxic assets, whose quoted prices are down around 20% or 30% of their face value, and the bankers say, "I'm sure these houses are eventually going to be worth much more than their currently quoted prices.   In other words, I don't want to mark their prices down to their currently-stated market value.   In short, I don't want to "mark them to market, or mark to market."

So all bankers are saying essentially the same thing:   'Please don't make me mark to market, because if you do, I'll soon have to declare bankruptcy.   If I accurately show, on my books, all those price reductions, from 100% of the original home value all the way down to 20% of the original home value, I've just wiped out my entire capital and more.   And then I'm going to have to go to the government and say, close me down, I'm broke and can't repay any of my depositors.  

Naturally, bankers find this quite hard to do.   And furthermore, regulators don't want it to happen to all the banks at once.   Certainly not all the big banks.   For they fear that this could well lead to a financial catastrophe for the entire country and perhaps the entire world.

Obviously, in the real world, the assets that the banks have on their books are more complicated than that for dollhouses.   But, if the banks had to sell them now, in today's market, they'd almost certainly take a huge loss -- a loss big enough to wipe out their capital and the capital of their depositors, and that would shut them down.

And it's not just a few banks.   Banking experts estimate that more than a thousand U.S. banks are either facing this situation right now or soon will be.   And that includes -- and this is the crucial point -- many of America's largest banks.   Bottom line:   They owe more money than they have.   And there's a nasty little word for this that no one wants to utter:   insolvent.

But you don't have to take my word for it.   Listen to Jeremy Siegel, who is known as the Wizard of Wharton -- Wharton of course being the famous business school.

Question posed to Jeremy:   How many banks right now do you think would be insolvent, if bank examiners came in and hard-headedly evaluated what they actually have on their books?

Jeremy replies:   "I wouldn't be surprised if Citi and Bank of America, if they were to acknowledge the current true value of their assets, they would no longer be able to cover depositors and bond holders and it would wipe out their shareholder equity."  

Translation:   Jeremy Siegel is saying that at two of the biggest banks in the US, their true assets are too small to cover their liabilities.   These losses, if acknowledged, would effectively wipe out their capital and there would not be enough left over to pay the depositors and all the other people who lent them money.   That is no small matter, it is huge.

It's true that depositors with a regular savings account would not lose any money under practically any scenario because the government guarantees their deposits up to 250,000 dollars.   And provided the FDIC didn't run out of funds, they'd all get their money back.   The problem is that big banks get lots of their money from big investors who lend them millions or even billions of dollars, and that money is not protected by the FDIC.   If the banks go down, because they are forced to face the truth and acknowledge it to one and all, these big investors could lose their billions, and the consequences of that would ripple around the world.   Therefore, the lie must be kept.   It must be maintained.   The truth must not be publicly acknowledged.   And it then becomes imperative that the Fed gives the banks enough money to keep them operational, restore confidence in the banking system as a whole, and pay their depositors whenever the depositors want their money.

Therefore, thanks to critically needed help (hundreds of billions of dollars in no-interest or virtually no-interest loans) from the Fed, big banks like Citibank and Bank of America are able to maintain the lie and haughtily dispute the claim that they're insolvent.   Based solely on their blind faith that the housing market is going to come back, both banks say they have more than enough capital and there's no need to worry.   And as long as our federal government can keep borrowing money from China and elsewhere around the world, thus allowing the Fed to create out of thin air all the additional billions that are needed by all these secretly insolvent banks, they are right:   there's no need to worry.

However, the market evidently does not believe the story that the banks are really solvent.   To wit:   Citibank claims on its balance sheet that it's worth more than $150 billion.   But if you add up all the Citibank stock out there, which is how you find out what the market thinks Citibank is worth right now, Citibank's total value, according to the stock market, is less than $10.   This is particularly alarming since Citibank historically has been one of the largest companies in the world.

So what you see here are two different stories.   What the banks are saying about their balance sheets is the first story.   And what people outside the banks (e.g. traders on Wall Street) are saying is the second.  Not surprisingly, the government is siding with the banks, at least for now.   And this lie must be kept if the economy is not to collapse.   At least that's what Obama's advisors have convinced him is the case.

What one thinks should be done about the banking crisis depends on which version of the truth you believe.   The Secretary of the Treasury and the Fed say that Citibank and all the major banks are well capitalized ...   and just need a little cushion for insurance, which the Fed is happy to provide, in the hundreds of billions.

So in a nutshell, here's the situation our country is in  

If the Wizard of Wharton and the stock market are right, two of our largest banks are either insolvent, or really, really close to it -- and so are lots of others most probably.   But just these two banks -- Citibank and Bank of America alone -- have over a quarter of all the money in the US banking system.   And more than 90% of all the money anybody has on deposit in the US is in just the 20 largest banks, most of which, if not all of them, are actually insolvent because of the absolutely huge amount of toxic mortgages that are on their books.   And if these banks should start falling, because of some reckless release of proof of the terrible truth about their true financial condition, the US economy and the world economy, are, basically, done for.   At least for a while.

So, what can we do?  

There are two options that have been widely discussed.   One option was the one that former Treasury Secretary Henry Paulson originally proposed with the first TARP -- which you'll remember stood for Troubled Asset Relief Program, and now those euphemistic words, "troubled asset," might make more sense.   The idea here is pretty simple.   Consider Caitlin's dollhouse as a typical troubled asset.   Houses like that are selling right now for only 50 dollars.   Under TARP the government agrees with Banker Bob that someday the market will pay a lot more for that dollhouse ...   and so it buys it from Banker Bob for a higher price than he could get now, were he to try and sell it on the open market -- let's say the "government" (his mother) gives him 92 dollars for that doll house -- very close to the original hundred that he loaned out to Caitlin so that she could buy it at that price.

In agreeing to the deal, Banker Bob's reasoning goes like this:   "I'll still take a hit to my capital:   I'll lose a lot of my money -- 8 of my 10-buck investment, but at least I'll get to keep my bank, and I'll keep my depositors, like Alex.

Problem is, we the taxpayers then get stuck with a 50-dollar dollhouse that we paid almost 100 dollars for.   And if dollhouse prices don't go up, it turns the government (and the underlying taxpayers) into pretty big suckers.   Besides, we're looking at a plan that bails out people like Banker Bob, even though he's the kind of guy who got us into this crisis by making unbelievably stupid loans to deadbeats like Caitlin, who the banks should have known were apt to lose their jobs in this failing economy with ever shrinking wages and ever scarcer jobs for the majority of the population.

Anyway, the government can't pay less for the dollhouse, can't get a better deal, because if it were to get a "good deal," i.e. if it were to only pay what the market would pay, that wouldn't save the banks.   Rather, it would defeat the whole purpose of this hocus-pocus operation that is currently being implemented.

But bankers like Bob love this plan.   They think it's brilliant, because sure, they'll lose some money but they're still in business.   They're still officially and ostensibly solvent.  

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So now let's hear from Simon Johnson, an economist who used to be with the International Monetary Fund, and is now with the Peterson Institute.   He's found a good example of another banker giving the hard sell for this plan.

The note Simon is presenting us with is from Deutsche Bank;   it's one of their US daily economic notes.   The title is eye-catching:   "Falling Short:   The Government Needs to Buy Toxic Assets."   So it's a very straight forward statement, and it speaks to current issues.   Here's the heart of its message from Deutsche:  

"Ultimately, the tax payer will pay, one way or another, either through greatly diminished job prospects or significantly higher taxes down the line.   Therefore, we think the government should do the following:   estimate the highest price it can pay for the various toxic assets residing on financial institution balance sheets which would still return the principal to the taxpayers."  

Now, let me translate that, says Simon Johnson:  

"This is a robbery note.   It's saying,   guys, you'll have 20% unemployment, and it will go up to these dangerous levels, unless you buy toxic assets -- not for what they're worth, not for what the market price is, but for as much as you can possibly pay.

The key line here is that the taxpayer will pay one way or another.   So basically what this note is saying is, look guys, you're going to be hurt either way, so just give us the money and we'll try to make it as easy for you as possible."

Simon Johnson continues:   "Upon reading this, my first reaction was that it's a spoof.   My second reaction was, Oh My God."

So now let's here from a Deutsche Bank guy, Joe Lavorgna:

"I think the bottom line is simply that someone has to pay for the mess that's been created and there's no escaping that, and ultimately the taxpayer is going to be on the hook, one way or the other."

So Joe Lavorgna is finally coming out and saying something that every other bank and lots of government people have avoided saying.   They've been playing this game -- saying there's some magical recipe where the government bails out the banks, the banks do better, and the taxpayers end up making money.   Everyone wins.   But this note from Deutsche Bank is saying what I keep hearing from economists:   that can't happen.   Someone is going to lose.   And Joe is saying he knows exactly who's going to lose:   you, and me, and everybody who pays taxes.

Simon Johnson replies to Joe:   "I found the note to be refreshingly honest, but it also kind of took my breath away.   And so I asked people on my blog what they thought.   I didn't use names.   I just put out this key paragraph from Deutsche Bank, discussing that the taxpayer will pay, one way or another.   One respondent offered the following interpretation of the note: "That sure is a nice global economy you've got.   Be a shame if anything happened to it."   So, Joe, do you mind if we call it a ransom note?

Joe Lavorgna's rejoinder:   "If I was on my own, I'd say fine.   But under the circumstances I wouldn't say ransom note, I would say a reality check.     Here's the issue.   We're delaying the pain, and you've got to just deal with the problem.   What we've done up until this point has just simply not been aggressive enough.   Whatever the approach is, let's just get there."  

But let's consider a second way the government could address this whole mess.   The government could say to bankers, okay dude, let's get real.   Banker Bob is just going to have to recognize his loss on Caitlin's dollhouse.   He's going to have to honestly admit that yes, he's 50 dollars in the hole.   So, his capital is wiped out.   Plus, he owes his depositor, Alex, 40 bucks.  

However, in this second plan, the government comes in on the other side of Banker Bob's balance sheet and covers his losses -- it provides 40 dollars to pay back Alex, and it replaces the 10 dollars in capital that got wiped out and that Banker Bob thought he had lost.   Now, however, the problem is, if the government puts in that much capital, then the government now essentially owns the bank.  

Bob's response to this is:   I don't like this plan.   I lose my job.   I don't like this kind of government takeover of private industry.   It's nationalization.   I hate nationalization.   This seems like socialism to me.

But, at least this way, as taxpayers, we have an ownership stake in a bank, not just some crappy, overvalued dollhouse.   The government will clean the bank up, sell it to someone else down the road, and ultimately we'll get most of our money back.   And frankly, the taxpayers don't really mind that the bankers will lose their job and their money.   After all, they're the ones who got us into this mess.    And, besides, this is the traditional way that governments around the world usually fix banks that get into this kind of a mess.

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For the last 20 years, Simon Johnson has worked on banking crises all over the world.   As already mentioned, he used to be the chief economist for the International Monetary Fund, an organization that has stepped in, over and over around the globe, to fix just the kind of crisis we're in now.   And the IMF with the United States pushed countries in similar situations to do what?   To nationalize their banks -- temporarily.   Examples:   Indonesia, 97, Korea, 97, 98, Russia, every couple of years, Argentina, in 2002.  

Simon Johnson continues:   "What would the U.S. tell the IMF to do if this were any country other than the U.S.?   Assume you covered up the name of the country, and just showed me the numbers, just show me the problems, talk to me a little about the politics in a generic way.   What would the U.S. tell the IMF to do?  I know what they would tell them and I know what the IMF would do:  Take over the banking system.   Clean it up and re-privatize the bank as soon as possible.

So why is the United States not taking its own advice?

Simon Johnson:   That is a great question.   A huge question.   My take is that it's too political.   The politics are awkward.   Cleaning up a banking system, is technically not that difficult.   But, when you clean up a banking system, and you do it properly, some powerful people lose.   They lose their bonuses, they lose their banks, they lose their access.     So which politicians are going to be the ones who are going to help bring the hammer down on the bankers who contribute so much to their campaign funds?   Frankly, I don't think most members of Congress are ready to even have that conversation.

One of the reasons they might not be ready to have that conversation has to do with the practical challenges of taking over the banks.   Columbia Business School professor David Beim knows about this.   He has experience assisting the U.S. government in taking over American banks.   This was back during our last banking crisis, the Savings and Loan crisis in the late 1980s.   When that crisis hit, Beim started advising the FDIC on the problem, which was a big one.

David Beim:   Every large bank in Texas and Oklahoma failed in that era.   Every one of them.   It was the biggest banking crisis America had faced since the Great Depression and yet, compared to what we have now, it was nothing.

What I faced in the '80s was a regional crisis; so that, the FDIC was willing to shut every major bank in Texas and Oklahoma and cleanse them of their bad loans, re-launch them with new management, and new shareholders.   That was the best practice of the day, and they did it very well, and they got through the mess.   And they got through it elegantly.   But it's much harder to do that for the nation as a whole.   It's harder to say, all the big banks should now be closed.   Much harder.  In fact, you would not want to do such a thing all at once.   This crisis has advanced so fast and so globally that such a rash move would be quite dangerous.   It's not just the United States, you see;   banks are on the verge of crashing all over Europe.   In fact, the banks of Europe are actually in worse shape than the banks in the United States.   Even the banks that never touched a mortgage-backed security are in worse shape.   This is a global crisis.   It's absolutely everywhere.   And under those circumstances it's much much more risky to advocate closing down all the banks.

Exactly what is the difficulty?   Is it simply that you need somebody to sell the assets to, and if you're taking over the biggest banks in the country, there's nobody to sell the assets to?

David Beim:   Yes.   You can easily sell one bank.   I'm sure you could put some buyers together -- there's private equity funds and others who I'm sure could be found for one bank.   But to buy the banking system of the globe is rather a tall order.

There's another practical challenge to taking over all of our insolvent banks.   The government might very well not have enough people to do it.   The one time the FDIC actually fully nationalized a U.S. bank -" which was Continental Illinois, in 1984 -- it took more than a hundred government regulators.   Citibank alone is 20 times bigger.   And the banking system is far more complicated now than it was then.   One expert told me we might be talking about thousands of people needed for each bank we take over.  

A second problem:   Nationalizations are kind of like potato chips.   It's hard to have just one.   You'd have to come out with a plan for all of them -- or all the big banks anyway -- and you'd have to do the whole thing in one day, at one time.   Because if you just start taking over one bank, people with money at other banks will start worrying that THEIR bank will be nationalized next, and that will cause investors to panic and they'll pull all their money out of that bank.

Simon Johnson, the economist who worked at the IMF, said he heard practical arguments against nationalization in every country he went into, and yet he feels sure there are ways to deal with all of the potential problems, re: timing, staffing etc.   He said it might be possible, for example, for the government to hold onto the banks for just a few hours before turning each of them back over to private investors.

Simon Johnson continues:   I'm sure that all the reasons for being apprehensive are sensible, but let me speak as if I were the IMF, acting on the behalf of, and with the support of, the U.S. government in the 1990's.   What I would say is, stop the whining.   You know it's got to be done.   Just do it.   The longer you wait, the more you prevaricate, . . the more it's going to cost you.   This is the U.S. government we're talking about.   These people, when they get organized, when they get focused, they get things done.   This is the greatest country ever on the face of the earth.   We have plenty of talent, there is no shortage of brainpower.   Just do it.

Now you might have noticed that the government isn't doing either of these options.   Instead, they're doing sort of halfway versions of both.

To wit:

The government has not committed to buying up all the toxic assets, from banks, at something closer to their full price.   But they have created a new trial program that allows the government to help subsidize private investors, who, they hope, will buy a lot of these assets.   And when it comes to this second option, the government is not forcing banks to sell their assets, or value them at what they could get on the market right now (i.e. mark to market).  

Nor is the government taking over the banks, i.e. they aren't nationalizing them.   In fact the government has gone out of its way to give banks money without taking control.   They've given the banks over $240 billion, including $45 billion to Citibank alone.   But the government structured the deal in a special way, specifically designed so it was not a nationalization.   And recently, when Citibank's troubles got worse, the government had to go through these amazing contortions to help the bank without becoming its owner.   All of them, from President Bush and Henry Paulson, to President Obama and Tim Geithner and Ben Bernanke, they all say the same thing:   They don't want the government owning banks.   Not even briefly.

Some people wonder if the government couldn't just let the banking system sort things out on its own.   If banks made bad bets, then they should go out of business.   It's not our problem.

However, the Federal Reserve Chairman, Ben Bernanke, dismissed this option when he told Congress in a private briefing, it actually is our problem.     He was quoted as saying, "If we let the banking system fail, no one will talk about the Great Depression anymore, because this will be so much worse."    It seems that a functioning economy desperately needs functional banks, which, Columbia Business School Professor David Beim says, is why governments always protect them.

So if the government won't let banks fail, and also won't take them over, that means that Citibank, Bank of America, JP Morgan Chase and three or four others -- have us over a barrel.   We can't just let them fail.   And it's going to cost us one way or another to keep them alive.   And this sucks.   I feel that, you feel that, Congress definitely feels that.

Or at least their constituents are communicating those feelings to Congress.   And this frustration leads to a lot of lashing out about almost exactly the wrong thing.   Here's Massachusetts congressman Mike Capuano yelling at the banks:

"Start loaning the money we gave you!   Get it onto the street!"

This might be a reasonable expectation for healthy banks, but for insolvent banks it can be a disaster, and the reasons all goes back to our balance sheet.   You see, when a bank is insolvent, it doesn't have enough capital to cover its losses.   So, in that situation, banks would actually be doing the RIGHT thing by keeping the bailout money that we're giving them -- not loaning it out.   An insolvent bank needs to hold onto their capital because that's how they fix their balance sheets.   If they loaned the money away, they'd be in danger of   returning to the very situation we're trying to rescue them from.   In other words, saving the banking system, means that the banks that are worst off, should loan less, not more.   And that of course is precisely why they are all so reluctant to make loans.

But beyond the balance sheet, David Beim has a much more profound reason why banks shouldn't lend.   Beim asks us to consider how much debt we the citizens of America, are really in.   How much do we all owe -- on our mortgages and credit cards and auto loans, in total -- compared to the economy as a whole, the GDP.   Keep in mind that throughout most of our history, the amount we owed was a lot smaller than the economy as a whole.   The ratio of just household debt alone, to GDP, has always bounced around between 30 and 50 percent, for most of the 1930s, '40s , 50s, 60s, and 70s, right into the 80s.   Then it breaks through 50 % in the mid 80s, starts heading up in the 1990s.   And then from 2000 to 2008, it just goes, almost like a hockey stick, virtually straight upward.   It quickly hits 100% of GDP.   That is to say that, currently, consumers alone owe 13 trillion dollars -- when the GDP is $13 trillion!  

Has there ever been a time where we owed that much before?

The earlier peak, which is way over on the left part of the chart, where debt is 100% of GDP, was in 1929.   So this graph is kind of like a map of twin peaks.   One in 1929 and one in 2007.

This chart is the most striking piece of evidence we have that what is happening to us is something that goes way beyond toxic assets in banks -- it's something that had little to do with mortgage securitization, or ethics on Wall Street, or anything else.   Basically it says the problem is us.   The problem is not the banks, greedy though they may be, overpaid though they may be.   The problem is us.   We -- at least the top third of income receivers -- have over-borrowed.   We in the top third have been living very high on the hog, mostly on borrowed money.   Our standard of living has been rising dramatically over the last 25 years, and the very large majority of us have been borrowing heavily to make much of that prosperity happen.  (Granted that most of the people in the bottom two-thirds of income receivers have borrowed out of necessity as their incomes and job prospects have shrunk.)

And so, when you hear Congress saying we need to make sure there are strings attached to this money the Fed loans the banks, i.e. to make sure they are lending it out, that doesn't make any sense at all, because we've already borrowed way too much.

David Beim:   It makes not only no sense, it makes reverse sense.   In other words, it's nonsense.   Because what the banks have done is already lend too much.   The name of this problem is too much debt.   We have over-borrowed, and we have done that over the span of many, many decades.   And now it's reached just an unbearable peak where people on average cannot repay the debts they've got.   In the face of that, it is not a solution to try to lend still more.

The government recently revealed the details of its plan to save the banks.   Now, remember, there are people out there who are saying the government has to act quickly to acknowledge the problems on bank balance sheets, declare insolvent banks insolvent, and step in aggressively to fix it all.   One person who believes that, is Simon Johnson, our former IMF official...

Simon Johnson: Yes, I think there's a level of deceit here.   Right, I'm part of "the banks," and I think the government is going along with the deceit far too much.   One of my colleagues nicely articulated what should have been our governing principle:   "No New Lies."   But the balance sheet of these banks is as far as we know a huge lie.   They don't want to show you, or even tell themselves, what all these toxic assets they own are really worth.   And we're saying, deal with it now, deal with it seriously, deal with the problems in the banking system openly.   Or, there will be hell to pay.

In other words, Simon Johnson is saying that every day we delay taking over insolvent banks, the economy gets weaker and the solution gets more difficult.  

Well, according to the plan that Obama's administration revealed this week, they have a different view, and they think it's best to go about things with much more deliberation.   In fact they recently announced that they're going to take two months to figure out how healthy the banks are -- that's the stress test you've heard a lot about.   And then they're going to take another 6 months to give some money to the banks that need it.   And they've said, to the media, and to Congress, that they're pretty sure they already know what those stress tests are going to find:   namely that America's biggest banks are healthy and that the government will never need to take them over.   In other words, the Obama administration is an active participant, with the big banks, in the Big Lie.

So, given a choice between a scary and unprecedented takeover of our banks immediately, . .   and   much smaller measures where they simply:

• strive to keep the banks afloat,
• don't challenge them too much on the truthfulness of their balance sheets, and
• hope that in time, things will sort themselves out -"

. . they're going with the latter option.   However, their public statements did leave them plenty of wiggle room.   And of course ...   if they WERE planning to take over the banking system ...   they wouldn't announce it beforehand.   They'd probably say exactly what they're saying right now, and wait till everything's set up, till they've secretly hired enough people and got all their plans in order, and then one Friday evening they'd make an announcement, and nationalize the banks over the weekend.

The bottom line is that solving the banking crisis means that somebody is just going to have to buy up these toxic assets, i.e. the stuff that is poisoning bank balance sheets and making banks insolvent.   And one of the main principles behind the Obama Administration strategy is that they are trying to get private investors to do as much of this buying up as possible.   So the administration has created all kinds of financial incentives and guarantees for investors to do just that.   Ultimately the taxpayers will pay for all this help the government is going to give these investors, but that cannot be our concern right now.   Not if we want to avoid economic and financial collapse.

Authors Bio:

Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've always been more interested in political economics and what's going on behind the scenes in politics, than in mechanical engineering, and because of that I've rarely worked more than 8 months a year, devoting much of the rest of the year to reading and writing about that which interests me most.