Now it's time to go back to three principles. There are three
* Do nothing.
* Bailout (a la Paulson)
* Nationalization (a la Sweden 1992)
Do nothing was last tried in 1929-1932. The result was called the Great Depression. Let's not do that again. Let's decide between bailout and nationalization. Nationalization has the best chance of avoiding large losses and possibly even making money for the taxpayer. And it is the best way to deal with the moral hazard problem.
Except Hoover didn't do nothing. In January 1932 he bailed out the banks:
Consider what happened during the 1930s. In the fall of 1931, the Hoover administration realized that financial institutions no longer held the trust of depositors, investors, businessmen or each other. These organizations were losing deposits so rapidly that the financial system faced complete collapse. These organizations needed to cleanse their balance sheets of assets, which under current conditions, had little immediate value and could not be used to raise cash.
In January 1932, the Hoover administration created the Reconstruction Finance Corp., an entity authorized to extend loans to all depository institutions in the nation. The RFC could accept as collateral a broad array of assets, including those deemed to be of little immediate worth but of potential long-term value. During its first year, the RFC lent nearly $1.5 billion and acquired equity stakes in thousands of financial institutions. As a share of the capital of the financial industry, this lending would be the equivalent of roughly $100 billion today. During its second and third years, the RFC extended loans to banks and acquired equity positions in financial institutions amounting to more than $3 billion dollars, equal to roughly $200 billion today.
The financial crisis slowed temporarily, but the bleeding continued. Bankers restricted lending to entrepreneurs, consumers and each other. Industrial production plummeted. Unemployment skyrocketed. The financial meltdown resumed, forcing the president to declare a national “banking holiday.”
It’s worth reiterating the theme of this historical analogy in stark terms. In the past, we faced a similar situation and employed similar policies. The policies marked a deepening of the downturn, not an end to the agony. The policies signaled the demise of the financial system and the need to construct new institutions.
It's time to let creative destruction run its course.