Treasury, in a tectonic shift, is now considering capitalizing banks with that $700 billion. This means rather than buying the toxic glop, they will take ownership stakes. Sweden did this a while back during their crisis. It worked – and the government eventually made a profit too.
The plan would be voluntary, but any bank that joined would then have its deposits and debt guaranteed by the US government, a huge market advantage against any bank that didn’t. Capitalizing the banks would directly inject money into the system and help unfreeze the credit markets. This could actually work.
Fed officials increasingly talk about the challenge they face with a phrase that President Bush used in another context: “regime change.”
This regime change refers to a change in the economic environment so radical that, at least for a while, economic policy makers will need to suspend what are usually sacred principles: minimal interference in free markets, gradualism and predictability.
Simon Johnson, former chief economist of the International Monetary Fund, has also called for recapitalizing the banks. He makes the sombre point that the consequences of Iceland’s bankruptcy will be both severe and reaching way beyond their borders. Emerging markets in general will get clobbered.