Is there any way we can grow out of this enough to detox enough assets (is this even the right question?)

FT.com | Willem Buiter's Maverecon | Why Weber is half right but completely wrong

It is clear that the logic behind this unwillingness of the authorities to let the banks go broke rests on a simple but fundamental confusion between the life of a particular legal entity and the well-being of its stake holders and the ability of an organisation to fulfil certain systemically important functions.  Klemperer and Bulow have proposed a `stroke of the pen' method for restoring the financial capacity of an under-capitalised bank.  Take the example of Commerzbank, Germany's second largest bank, which has been offered  euro 18.2 billion in German state support.  If Commerzbank needs additional capital and cannot get it in the market, and if Commerzbank is deemed systemically important, it could (and should) have been put into a special resolution regime for banks and split into a good bank (Gute Commerz) and a bad bank (Schlechte Commerz).  Gute Commerz would have all the assets of the old Commerzbank - Alte Commerz -, but only the insured deposits on its liability side.  All other liabilities (the unsecured, uninsured creditors) would be put into Schlechte Commerz.  Schlechte Commerz would have the equity in Gute Commerz as its only asset.

Gute Commerz would be highly capitalised, after what amounts to a massive mandatory debt-into-equity swap.  The shareholders and unsecured creditors of Alte Commerz are no worse off than they would have been had Commerzbank/Alte Commerz been liquidated.

This whole exercise could be done in about 15 minutes.  Gute Commerz would continue to operate much as Alte Commerz did before, but with massively more capital.  It may be necessary in some countries to establish in law the seniority of insured depositors over other unsecured creditors.  Dr. Weber should focus his energies on getting such legislation passed in Germany, and indeed in the entire Euro Area and EU.  It may even be necessary to single out certain claimants on the bank (e.g. some counterparties of Alte Commerz in the derivatives markets, such as the CDS markets) for retention as counterparties of the Gute Commerz rather than putting them into Slechte Commerz.  Again, that would require legislation establishing the seniority rankings of different unsecured creditors and holders of contingent claims on banks.  I am unconvinced by the argument that certain counterparties of the banks should be made senior to other unsecured creditors, but as long as a sufficient number of unsecured creditors of Alte Commerz are sent into Slechte Commerz, it does not affect the viability of the Bulow-Klemperer proposal.

OK, now, suppose we do it this way. Bank examiners do "stress testing", which is to say, a real world audit instead of the fantasy audits that we have been doing in order to avoid official recognition of the depths of the problem. And banks that are in too much financial peril to be allowed to continue operating as they have been doing ... are put into receivership.

Now, the US government strips out the liabilities that we wish to protect ... the account liabilities ... and takes over the "good" assets. If that is a net plus, the government pays the original bank for the positive net assets. If that is a net minus, the government makes up the difference with the new Good Bank, and takes a compensating Senior claim in the old Bad Bank.

Then the residual of the old Bad Bank is run through ordinary Chapter 11 proceedings ... in most cases the shareholders will be zeroed out, the bondholders will become shareholders, the new shareholders are quite likely to sack the old senior executive management, and the old Bad Bank will see what they can do to recover whatever value can be had in the trash that forms their asset base.