I believe we reached a point of

Peak Credit

last year when the pyramid of credit exceeded the ability of the available Capital base to support it.

As I said...

But let's stand back for a moment and consider the actual economic function of a bank ... in fact what it actually does is provide a guarantee to its depositors that its borrowers' credit is good. The interest charge the bank makes for doing this has to cover the interest it pays to depositors, operating costs and default costs, and will normally produce a net profit.

If you think about it, trade credit from seller to buyer costs nothing to create, and of course bank credit costs nothing to create either: so it is the implicit bank guarantees that represent the economic value they provide. Regulators - overseen by the Basel-based Bank of International Settlements - specify and monitor the amounts of regulatory capital which must be held to support this guarantee.

The problem has been that in recent years banks have been outsourcing their guarantee to investors: permanently through securitization, temporarily through credit derivatives, and partially through insurance, by monoline (ie with a single line of business) credit insurers, such as Ambac.

By using investors' capital to augment their own, a much greater pool of credit has been created than banks could ever have sustained on the basis of their own resources. Unfortunately, this has been done in such an opaque way that no one actually knows who is at risk. The market in such investments has now frozen as investors have gone on strike, probably permanently.

While the bailout should have the effect of stemming the haemorrhage of bank capital, it will not mean that they will lend on anything like the terms they were doing before. The bailout will not make investors more likely to take on credit risk as they were doing before, nor will it make it more likely that investors will recapitalise banks.

The outcome will be a continuing fall in property prices, probably to levels not seen for 20 or 30 years.
In my view the system is in terminal decline.

The logical step would be for the Treasury to issue new unsecured credit directly to borrowers, and for the process to be managed by banks as service providers. No "interest" would be collected, but a service charge would be made, and a provision made into a Default Fund. Banks would be obliged to take a share in any defaults, to keep them honest, but they would no longer risk their own capital by creating credit based upon it.

In relation to the refinancing of the vast and increasing number of existing disteressed mortgage loans, and the repayment of new credit which finances newly developed property, I advocate the "Unitisation" of the rental value of property through new generic quasi REIT's.  

This would have the effect of monetising real property rentals.

"The future is already here -- it's just not very evenly distributed" William Gibson