After the stress tests I think we need to go either toward nationalization or letting the bad banks fail. However, with the changes in accounting rules I worry that banks that are basically insolvent will still limp along since they can practically define their own solvency.

This route exposes taxpayers to the risk these banks represent should they turn out to be even more troubled than we thought. If the gov’t had instead said “no thank-you,” insolvent banks would have been let to fail.

Only stock and bond holders in the banks would be exposed. It IS important to note that many of these investors are institutional ones like pension funds. So if these banks were let to fail, taxpayers would be on the hook for things like pension and money market guarantees the gov’t has made.

But that would mean we wouldn’t be bailing out ALL bank investors, so there’d be some savings. And with the money not spent recapitalizing banks, thr gov’t could have stepped in as the direct maker of the credit markets while the crappy banks collapsed and the healthy ones thrived, gradually weaning off its role as market maker.

We might still end up stuck going that way, only AFTER more of the insolvency is exposed. Just wait ’til the wave of commercial real estate write downs begins in earnest. And after that, we’ll see the peak in the defaults on liar loans and negative amortization loans.

All this deleveraging apparently has a long ways to go yet.