The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?

The big banks are insolvent and  pumping more money into them will only prolong and worsen the crisis.

This can be true only to some degree. If you pump enough money into banks at some point they have to become solvent again. Their liabilities are not infinite.

Without gov't assistance? Marked to market and not fantasy?
At least 7 out of the ten largest banks in Germany would be insolvent.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

The president has an economic program. But there is, so far, no clear statement of the thinking behind that program, and there may not be one, until the first report of the new Council of Economic Advisers appears next year. We therefore resort to what we know about the economists: the chair of the National Economic Council, Lawrence Summers; the CEA chair, Christina Romer; the budget director, Peter Orszag; and their titular head, Treasury Secretary Timothy Geithner. This is plainly a capable, close-knit group, acting with energy and commitment. Deficiencies of their program cannot, therefore, be blamed on incompetence. Rather, if deficiencies exist, they probably result from their shared background and creed--in short, from the limitations of their ideas.

The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. (Federal Reserve Chairman Ben Bernanke said it reflexively in a major speech in London in January: "The global economy will recover." He did not say how he knew.) The difference between conservatives and liberals is over whether policy can usefully speed things up. Conservatives say no, liberals say yes, and on this point Obama's economists lean left. Hence the priority they gave, in their first days, to the stimulus package.

...

Why did the CBO reach this conclusion? On depth, CBO's model is based on the postwar experience, and such models cannot predict outcomes more serious than anything already seen. If we are facing a downturn worse than 1982, our computers won't tell us; we will be surprised. And if the slump is destined to drag on, the computers won't tell us that either. Baked into the CBO model we find a "natural rate of unemployment" of 4.8 percent; the model moves the economy back toward that value no matter what. In the real world, however, there is no reason to believe this will happen. Some alternative forecasts, freed of the mystical return to "normal," now project a GDP gap twice as large as the CBO model predicts, and with no near-term recovery at all.

I recently came up with the following metaphor.

Economists reason in terms of a "general equilibrium" which they assume is stable. Picture the economy as a ball rolling inside a bowl, oscillating around the bottom point. Economists don't even concern themselves with the approach to equilibrium, which they assume is quick enough, or else they concern themselves with the "long term". So what they do is they study how the equilibrium point changes when you change some choice parameters.

Maybe a better metaphor for the economy would be a pencil balanced on its tip, or a ball rolling on the outside of an upside-down bowl. There is an equilibrium position on top, but it is unstable and in order to keep the ball at the top or the pencil balanced on your fingertip you have to carefully but vigorously move the bowl or the finger.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness, meaning a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can't qualify for loans. The other requirement is a willingness to borrow, motivated by what Keynes called the "animal spirits" of entrepreneurial enthusiasm. In a slump, such optimism is scarce. Even if people have collateral, they want the security of cash. And it is precisely because they want cash that they will not deplete their reserves by plunking down a payment on a new car.

In Europe you have a European Commission infected with Market Fundamentalism (and I'm not just talking about the Commissioners but also the "civil service") and the likelihood of a consensus in the Council and the Parliament to move away from Market Fundamentalism is slim. In addition, the Commission and the Central Bank are required by their statutes to push economic "liberalisation".

So the US is more likely to start moving away from Market Fundamentalism than the EU.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

Daily Kos:  The Economy: "No Return to Normal" - Galbraith UPDATED

Nice Diary, NB Books, we could use it to spice up EuroTrib tonight!

Humpty Dumpty is definitely broken, and can't be put back together again.

The first point is that most of the capital that underpinned the Mother of All Bubbles didn't come from banks, it came from investors, many of them overseas, through the mechanisms of securitisation, credit derivatives, credit insurance, and toxic cocktails of these three.

So while recapitalising Banks might treat the visible wounds, it won't stop the invisible internal bleeding of credit from the shadow banking part of the economy, and the further collapse of asset prices and disappearance of jobs.

The second point is that pumping capital into banks, and providing them with more liquidity through buying up their holdings of debt will not make their potential borrowers any more creditworthy than they have now become.

So the shortage is not of credit, it's of creditworthy borrowers. Monetary solutions are IMHO doomed to failure. and the Fed is utterly powerless.

The only solutions are fiscal.

The effect of the existing system of financial capital - a toxic combination of leverage and private property in commons - has been to transfer wealth from the 99% to the 1% who are even now clamouring that the 99% are to blame and should bail out the 1%.

This is the effect of what Jerome calls the Anglo Disease.

Apart from the stimulus of investment in public assets - a Green New Deal etc - and massive investment in public services, I believe that Systemic Fiscal Reform is necessary.

Simply put, we should tax Privilege and not People.

All taxes on earned income and profits, and transaction taxes should be abolished, as should means-tested benefits.

To replace them I advocate:

(a) Location Benefit Levy - a tax on the rental value of land.  This is a tax on the privilege of exclusive occupation of the Commons of land;

(b) Carbon Levy - a tax on the privilege of the exclusive use of the commons of non-renewable energy;

(c) Limited Liability Levy - a levy on the GROSS revenues of Corporations - this is a tax on the privilege enjoyed by investors of limitation of liability.

From the proceeds I would pay a National Dividend - as of right - to all citizens, and provide decent education and health services to all within a framework of what Dr Yunus of Grameen Bank calls "Social Business" operating on a "Not for Loss" basis.

The savings in the operating costs of the existing fiscal system - both in the Public and private sectors - would be phenomenal, and those involved would be far happier doing something socially useful, I suspect....

There we are. Solved the problems of the World. ;-)

Now back to ET....

Third, the initial package was affected by the new team's desire to get past this crisis and to return to the familiar problems of their past lives. For these protégés of Robert Rubin, veterans in several cases of Rubin's Hamilton Project, a key preconception has always been the budget deficit and what they call the "entitlement problem." This is D.C.-speak for rolling back Social Security and Medicare, opening new markets for fund managers and private insurers, behind a wave of budget babble about "long-term deficits" and "unfunded liabilities." To this our new president is not immune. Even before the inauguration Obama was moved to commit to "entitlement reform," and on February 23 he convened what he called a "fiscal responsibility summit." The idea took hold that after two years or so of big spending, the return to normal would be under way, and the costs of fiscal relief and infrastructure improvement might be recouped, in part by taking a pound of flesh from the incomes and health care of the old.

One of the more irritating lacks of US political and economic analysts (sic) is their operative ignorance of historical data and knowledge coupled with a inability to grasp social, cultural, economic, political ... anything - really ... as dynamic trends.

All "normal" means - operative definition - is the analyst expects the Universe to run along as it ran during the time the analyst was impressionable.  

To which I reply, "Get a brian, moran."

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

The Geithner plan has now been leaked in detail. It's exactly the plan that was widely analyzed -- and found wanting -- a couple of weeks ago. The zombie ideas have won.

The Obama administration is now completely wedded to the idea that there's nothing fundamentally wrong with the financial system -- that what we're facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.

To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad -- I mean misunderstood -- assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.

But it's immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating -- deliberately! -- the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn't, that's someone else's problem.

Read it and weep.

Capitalism searches out the darkest corners of human potential, and mainlines them.

When I left Credit Lyonnais in 1985 it was because I'd seen the bank being conned out of tens of millions by a couple of mafiosi, and since I wasn't in a position to persuade anyone of that fact, I bailed out. That's also why we left the US in 2005. A country being run by the joined intellects of Tony Soprano and Sauron isn't the ideal place if you want to enjoy your golden years in peace.

Without being 100% in agreement with Kunstler and others like him, I've been saying for a while that we're headed for a global collapse/transformative decade.

I believe that most of the concerns I see discussed in this thread will pale before far more important concerns which are/will be: food, shelter, transportation and security.

Our local rag LA DEPECHE DU MIDI had its front page today about people starting to grow food in their gardens, and last week about modern-day Robin Hoods stealing food from supermarkets to give to the poor.

The times, they're a-changin'.