Will Hutton writes in his Observer column that "big public stakes in banks and offer guarantees to the interbank market [...] is a necessary condition for stabilisation [but] it is not sufficient."
While I agree with Will that we need to sort out the "black hole" of the Credit Default Swap insurance pyramid, I think that the time for recapitlaisation is now passed. Recapitalisation is not a necessary condition for stabilisation. The rapid creation of a new state lending bank is what is needed.
Recapitalisation might once have worked: financial pyramids are a confidence trick, and a state recapitalisation of the order of a few percentage points of GDP might have allowed a gradual, orderly wind-down of the massive liabilities. But the kind of confidence that would allow a gradual, muddle-through solution of the sort that happened in the Latin American debt crisis of the 1980s is simply no longer there. Barclays and RBS alone are the ultimate insurers against default of contracts worth more than the annual income of the UK. These are the sorts of contracts which, in an auction on Friday of Lehman Brother's assets, went for less than one tenth of their face value. The trouble with nationalisation and recapitalisation is that the liabilities do not disappear. When the slate is this heavy, you need bankruptcy to wipe it clean.
The financial sector is scrabbling aorund for whatever cash it can lay its hands on because every institution is likely to find itself in the position of having to pay out on insurance contracts with other parts of the financial sector that they know they cannot currently cover. The taxpayer with our capital injectionshave become the latest source of that cash, and we will see it disappear into the black hole of CDS liabilities.
The time for confidence tricks is passed. The banks are bankrupt.Time to stop putting in good money after bad -- it simply will not help.
Save the real economy by rapidly creating a State bank that will lend directly to business, and let the finance system diappear into the black hole that it has dug for itself.
