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The fix isn't working.  It is doubtful that it can work.  The problem is that no bank trusts other banks, and with good reason.  They don't know if they will be in existence next week or next month.  No one can provide credible assurance of creditworthiness.  No one is confident that credit guarantees will still work. Fear of counter-parties is paralyzing the financial system.  Companies and governments cannot find affordable financing for their short term obligations.  Commercial letters of credit are not credible and that is causing international shipments and trade to stop.  There is no quick way to repair existing institutions.

Therefore the best short term solution is to create new, untainted banks with government backing. If they are required to follow conservative practices and to direct their lending to commercial credit, or commercial paper, letters of credit for trade, student loans, consumer credit and mortgages the economy could be unfrozen.  Since banks in the US typically are required to have a 3% capital reserve, $267 billion from the US Treasury to new banks would create $8.9 trillion of new loan capacity.  That is over half of last year's Gross Domestic Product and it should suffice to defrost the credit markets in the USA.

Similar actions of proportionate scale in Europe and Asia will likely be required.  Once that has been accomplished the real economy will be released from its condition of being held hostage to the financial industry world wide.  Existing banks in the USA can be taken over by the FDIC as required, with their depositors protected they can be shorn of their toxic assets, which should be left with the bank holding companies, and merged with one of the new banks or recapitalized by the government in return for preferred senior stock and provided with new top management.  Former management can look to the holding company for their golden parachutes.

Solving the credit crunch isn't rocket science.  It just requires abandoning the idea of saving existing institutions as the first and only priority.  Save the economy and the existing financial sector can be left to burn.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Oct 11th, 2008 at 08:19:55 PM EST

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