Madoff's Accountant Charged

The SEC had finally decided to take action against Madoff's accountant, David G. Friehling, for enabling Madoff's fraud.  

The SEC's complaint alleges that Friehling enabled Madoff's Ponzi scheme by falsely stating, in annual audit reports, that F&H audited BMIS financial statements pursuant to Generally Accepted Auditing Standards (GAAS), including the requirements to maintain auditor independence and perform audit procedures regarding custody of securities.

The SEC's position is that Friehling enabled Madoff's fraud by conducting an audit but not following accounting standards.  In other words, Friehling sold his accounting license to Madoff. 

Instead, the SEC alleges that Friehling merely pretended to conduct minimal audit procedures of certain accounts to make it seem like he was conducting an audit, and then failed to document his purported findings and conclusions as required under GAAS. If properly stated, those financial statements, along with BMIS related disclosures regarding reserve requirements, would have shown that BMIS owed tens of billions of dollars in additional liabilities to its customers and was therefore insolvent.

In other words, Friehling sold his accounting license to Madoff. 

AIG Bonus Firestorm Misdirects Attention Away From CDS Payments

An incredible amount of outrage has been written and expressed about the $165 Million in bonuses paid by taxpayer owned AIG, and rightfully so, but the AIG bonus issue is simply a misdirection of the real outrage - the payment of $60 Billion in credit default swap bets with taxpayer bailout money. The fact remains that pouring money into AIG is pouring money into a black hole.

The outcry is building about the AIG bonuses.  President Obama knew about the payments by at least last Thursday, and his administration knew before then. The Treasury is now making noise about either recouping the funds paid on bonuses, or reducing the next tranche of bailout funds.  Provisions are being floated around Congress to tax the bonuses at varying levels.  Frankly, while I am loathe to suggest that Congress use tax policy to penalize anyone, in this instance it could be a winner.  Tax the bonus recipients at the 75-90% level (states will follow suit as well), make the excessive payments non-deductible by AIG.  Taxpayers will recover the bonus payment and AIG will still be responsible for paying back the money borrowed (which will never happen). 

Whatever solution is proposed, however, only focuses on the bonuses.  The real outrage is the payout of billions to CDS counterparties.  Last week, AIG disclosed that it used the bailout funds to bailout its credit default swap counterparties at the same time Treasury learned of the bonuses.  Payments went to Germany's Deutsche Bank, France's Societe Generale, England's Barclay's, Spain's Banco Santander, and many others, including Goldman Sachs, Merrill Lynch, UBS, Royal Bank of Scotland, Bank of America, and Bank of Montreal.  Follow the money - this is nothing more than backdoor bailouts.  Taxpayer funds went to AIG, and AIG in turn distributed the money not only to US institutions, but international financial entities.  That means that we, the taxpayer, are not only bailing out AIG from its bad business decisions, but we are bailing out foreign counterparties that took a risk that AIG would pay off its bets.  

Where is the outrage?  The amount spent on these bailouts far exceeds the bonus payments, yet despite knowing last Thursday about the bonuses, President Obama timed his expression of outrage to coincide with AIG's disclosure of payments to counterparties.  While it isn't a cover-up, it certainly looks like our attention is being misdirected away from a major problem to focus on a relatively small problem.  It is unlikely that the taxpayers will ever see the $170 Billion of bailout funds repaid - and certainly any payment will not be made with equivalent dollars (but that is another topic), and it is likely that unless something is done, the taxpayers will continue to fund the losing propositions made by AIG and the other banks.  We are, however, not helpless while waiting (futilely) for the government to do something.  We can take matters into our own hands and stop doing business with AIG.  It is very simple.  Look at all your insurance policies and find out if any of the issuers are subsidiaries of AIG.  If so, cancel the policy and replace it with a policy from another, more solvent insurer.  

Don't Revive Glass-Steagall

Over the past few weeks I have read several proposed solutions to the current banking crisis that seem to advocate for a return to the flawed regulatory system put in place after the Great Depression 1.0. In particular, there have been several suggestions that Glass-Steagall should be reinstated. Glass-Steagall, officially known as the Banking Act of 1933, not only established our deposit insurance system (FDIC), but separated deposit banking from investment banking.  66 years later, in 1999, President Clinton signed into law the Gramm-Leach-Bliley Act that repealed the portion of Glass-Steagall that once again permitted integrated financial services companies. Reinstating Glass-Steagall will not prevent the systemic crisis that has occurred with our banking system. The tools are already in place that could have prevented the coming collapse, but it is the failure of government to use those tools to provide transparency to the markets that has set up the situation.

 Our entire system is based on faith and credit (in the sense of trust). There can only be full faith and credit with full transparency. (See, Faith and Credit - Act Now to Restore Confidence.) Full transparency means that banks that accept other people's money (depositors, stockholder, bondholders) must report fully and accurately its assets and liabilities. As a depositor, I want to know whether the bank that holds my money is taking excessive risk or gearing up with excessive leverage.  The government's role should be to ensure the transparency of the markets, and my deposit bank in particular, with timely and accurate disclosures so that risk may be assessed. If my bank's leverage ratio goes to high, I will need information to make a decision as to whether I will keep my money in the bank or move to another, safer institution.  

The trouble is, that our government has abandoned its role in ensuring transparency. The FDIC will not disclose its bank ratings out of fear that depositors will do just what they should do - take their money and run. To date, Congress is refusing to enforce mark to market accounting - which means that no one really knows the value of assets on the banks' balance sheets (and thus also obfuscates the leverage ratio). Frankly, if the assets can not be readily valued, they should not be counted as assets at all, and should not go into the leverage/reserve requirement calculations.  Banks play games with their leverage as well by sweeping in deposits overnight only to re-lend them to the same borrowers the next day. The bottom line is that noone can tell what the banks assets are worth or what its leverage ratio is. A few bloggers, including Karl Denninger (who unfortunately also advocates for reinstating Glass-Steagall), have suggested that reporting daily leverage ratios will help. Frankly, in this day and age, with there is no reason that we cannot have much more frequent financial reporting than on a quarterly basis. Daily reporting may be overkill, but it is the kind of step that will provide the transparency that is needed to save the system. Once a loan goes bad or an asset is devalued, the depositors and investors will know and can use that information to make an informed decision. That transparency will provide faith and credit in our system. Strong, conservative institutions will be rewarded with numerous depositors, and riskier ones will find the type of depositors that are willing to bear the risk.

At the same time, while ensuring disclosure, we need to make sure the government does not rig the system to play favorites or put us at a competitive disadvantage. Government needs to take steps to make sure true and accurate information is available, but cannot intervene in the workings of the market. Government intervention and market regulation simply will not help instill faith in the banking system or cause anyone to give credit to the banks. Reinstating Glass-Steagall, or other artificial devices from the GD 1.0 such as the uptick rule and unit banking, will only weaken our system and put it at a competitive disadvantage with other countries banking systems, and delay recovery. Keep in mind, that Congress separated comercial banks from investment banks at the same time it instituted guaranteed deposits.  The government wanted to make sure that there would be a way to finance the system risk free.  Separating the banks removed that risk somewhat.  However, even with those market regulation devices, systemic collapse was and is still possible.  If the goal is to make sure there is enough funds for deposit insurance, the banks should be assessed fees (premiums) in accordance with the risk they take.  In other words, if a combined financial services entity is deemed more at risk than a stand alone savings bank, then the premiums it should contribute to the FDIC should be greater.  Another point to remember is that Glass-Steagall did not prevent integrated financial services companies.  We still had those entities we referred to as "non-bank banks" and a whole host of other entities that circumvented the Glass-Steagall prohibition.  A return to those days will only prevent the financial institutions from regaining strength, and make them more susceptible to risk from economic cycles.  Not to rehash arguments made before the passage of GLB, but it was noted by both parties in Congress that money flowed out of deposit institutions and into investment banks during economic booms, and the reverse occurred during economic busts.  Allowing diversified financial institutions actually strengthened the system.

What destroyed the system was the abdication of reporting oversight.  The truth was obscured.  Without sunshine, depositors and investors play a rigged game.  What the people need is knowledge and accurate information, not the government assuming the role of a parent dictating which practices are good and allowable, which ones are bad and prohibited. If faith and credit are the key to the system, then transparency is the lock into which that key fits.

 

Why Not Let Insolvent Banks Fail?

Over the weekend, Senators Richard Shelby and John McCain finally floated the idea of letting big banks fail.  After spending billions of taxpayer dollars trying to prop up large but insolvent financial institutions, 2 of 100 Senators are finally realizing the black hole they have created.

The debate is now turning to nationalization.  Let's get some terminology straight - nationalization in this context does not mean having the government run the banks indefinitely. It is a temporary solution to provide an orderly liqidation of the banks.  We do it all the time with smaller banks that become insolvent.  That is the role of the FDIC.  The problem is that the FDIC is ill equiped to handle an insolvency of the size of Citigroup, Bank of America, or even non-bank groups like AIG.  

The solution is to let the banks fail under government control.  Government liquidation oversight will allow time for a replacement banking system to become established.  As part of the process, the governement could even create a new banking system now.  In fact, we already have a banking system in place - local community banks!

The real debate is the difference between Wall Street and Main Street.  Wall Street is dominated by a few very large institutions seeking the largest deals at the upper echelon of finance.  Without doubt some portion of our economy is dependent upon the financing brought by some of these large institutions.  On the other hand, we are told all the time that small business is the engine of the economy.  Small business creates jobs.  It is also true that small business does not do business with Wall Street.

Who finances small business?  The thousands of smaller regional and local banks!  That is right, our economy is not solely dependent upon Wall Street.  It is dependent upon Main Street.  The FDIC does not hesitate to pull the plug on Main Street banks, so why are we hesitating to pull the plug on Wall Street banks?  There is no reason to do so.  Lending will still occur, commerce will continue.  We will be healthier if we stop the bleeding.

Congress needs to understand that we cannot keep using taxpayer funds to replace business losses incurred by large Wall Street financial institutions.  Whether you take our money by taxation or by devaluing currency by printing more, or increase costs by borrowing more, the result is the same:  Main Street bears the brunt of the government action.  There is no just reason for shifting the burden of bad business decisions to the general public.  The failure to allow banks to fail is the failure to govern.  Stop the bleeding now.

FAITH AND CREDIT – ACT NOW TO RESTORE CONFIDENCE

All markets and all free governments are based on faith and credit.  Today we have lost all faith and credit in not only the markets, but we are on the verge of losing our faith and credit in our form of government.  Credit and faith can be lost for a variety of reasons, but the actions of the US Government – including the recent acts by the Obama administration, as well as the Bush administration and Congress – have engendered a monumental loss of confidence in both systems.

When rules are established to induce people to participate in a system, the rules need to be followed and unacceptable variations from the rules need to be corrected swiftly.  We are not doing that and as a result are undermining our entire system and way of life.  The term credit is derived from the latin word creditum meaning something entrusted to another.  The key concept is trust.  Faith on the other hand is derived from the term fides but also has its roots in trust and belief that one will honor their credit.  When rules are not enforced we lose trust in the system.  We lose faith that the credit we place in the markets and in government will be honored.

When we place our own money in a system, we expect that there will be uniform rules.  We credit the system with being if not fair at least consistent.  When we pledge allegiance to a form of government, our consent to be governed is based on the credit we place in the government to act fairly, impartially and with prudence.  We also have faith that the markets will return our funds, or at least give us the bargain that we thought we made.  In the same vein, we have faith that our government will not take actions in an arbitrary, capricious manner, and we have faith that our government will regulate the markets with fidelity.

One of the essential functions of all governments is to regulate the markets so everyone will have confidence in the system.  From time immemorial, governments intervened in markets for the benefit of those governed.  The most basic example is the setting of standard weights and measures. When you go to any market to buy a pint of milk or a bushel of corn or a pound of beef you have faith that the merchant is giving you the pint, bushel or pound for the bargained for price.  If those weights and measures were not standardized, you would not have faith in the system and you would not place any credit with the merchant.  You and others would simply choose not to do business in that market.  It is no surprise that the US Constitution confers on Congress not only the power to regulate commerce, but to specifically fix the standards of weights and measures.

The precarious position we are in today is a direct result of the abdication of the government’s power to root out fraud in the system – the most pernicious deviation from the standards set for the market and government itself.  Much has been written already about the fraud existing in the system.  Not the common garden variety type fraud like those perpetrated by the Madoffs and Stanfords of the world (see, Fraud, Fraud, Fraud), but the systemic fraud that is hidden from ordinary market participants, but when aggregated form a larger fraud than any perpetrated before.  When the game is rigged, people take their money and go home.  The massive withdrawal of funds from the markets and the amount of cash sitting on the sidelines is a direct result of the government’s failure to act to root out the fraud and create a level playing field.  The money won’t come back and the values of the baby boomer’s retirement accounts will not return, if ever, until the system is fixed.

The following are just a few examples of the systemic fraud that needs to be rooted out before faith and credit will be restored to the markets and our system of government:

1.       Continuing to bail out financial institutions at taxpayer expense when the institutions are insolvent and can’t be saved (for example, see Aig Black Hole - Us Continues To Pour Money Into Saving The Insurer );

2.                 Shifting losses from risk assumed by businesses to the taxpayers;

3.                 Refusing to regulate the credit default swap market;

4.                 Refusing to prosecute those borrowers who lied on their mortgage applications;

5.                 Refusing to take action against lenders and mortgage brokers who knowingly facilitated loans based on falsified mortgage applications;

6.                 Refusing to take action against the various ratings agencies that were paid to classify securities as AAA when they were based on falsified applications;

7.                 Refusal to prosecute those involved in the fraud and failure to enact legislation authorizing citizens to act as private attorneys general to ferret out the fraud (see, Hold Those Responsible Accountable!) ;

8.                 Refusal to impose mark to market accounting rules immediately;

9.                 Refusal to identify the recipients of taxpayer funds and to keep the markets, as well as government action, transparent (see Fed Still Refuses To Identify Recipients Of Our Money)    ; and

10.             Spinning official messages to give the impression that certain action is being taken when the exact opposite is being planned (see, e.g., Obama Calls For Fiscal Responsibility - Yeah, Right! and Fiscal Responsibility Summit Held to Pull Wool Over Nations Eyes).

There are many more examples, but the bottom line is that confidence needs to be restored to the system.  Fraud needs to be rooted out.  Wasteful spending needs to stop.  Playing favorites needs to end.  Effective representation of the people and the States needs to begin anew.  Only then will faith and credit be restored.

Fraud, Fraud, Fraud

Every boom market has fraudulent schemes that are only uncovered when the markets reverse.  Today the SEC was busy announcing 3 new fraud cases.  Certainly these are not of the magnitude of Madoff or Sandford, but they are significant.  First up was Westgate Capital Management LLC and its principal James Nicholson, who were charged with using an unregistered hedge fund to fraudulently take other people's money.  The SEC Press Release stated that Nicholson and Westgate defrauded current and prospective investors in 11 hedge funds they managed by misrepresenting the value of the hedge funds to investors, and soliciting new investors with sales materials that claimed a nearly impossible record of investment success.  Apparently, Nicholson created a fictitious accounting firm and produced bogus financial statements.

Action was also taken against Paul Greenwood and Stephen Walsh for defrauding investors out of $500 Million Dollars.  According to the SEC, these folks and their companies convinced institutional investors (public pensions, educational institutions,  retirement funds) to invest in a stock index arbitrage strategy.  Instead of making investments, Greenwood and Walsh purchased multi-million dollar homes, horse farms, exotic vehicles, etc.  The fraud was going on since 1996!

Rounding out the trio of fraud cases  is the one launched against Mark Bloom and his firm North Hills Management LLC.  This relatively small case - involving a mere $30 Million defrauded from about 40-50 investors since 2001 - seems like a common case of fraud.  Apparently, according to the SEC, Bloom obtained the funds to be invested in diverse hedge funds.  Instead, he used about $13 Million to buy homes, boats, cars and support a lavish lifestyle.  The balance of the money was put into a fund that was fraudulent itself.  

It seems that the amount of fraud going on this time was extreme.  But going after a few headline cases this time may not be enough.  In ordinary times ferreting out the fraud is necessary to maintain confidence in the system.  This time the level of fraud occurred at every stage.  The government needs to get serious about prosecuting the fraud to restore confidence in the markets.  The cases need to be filed not only against those involved in garden variety fraud, but cases need to be filed against the rating agencies that deliberately over-rated securities, from the banks that put mortgages in collateralized securities knowing the mortgages were no good, to the borrowers that lied on their applications.  Purging the system is what is needed.  Having the government fulfill its fundemental obligation of pursuing these crimes is needed on a large scale.  If the government cant do it, then consider authorizing private attorneys general to hold those responsible for the fraud accountable.

CItigroup Is Near Nationalization - Updated

There is much attention this morning to reports that the US may not only convert its $45 Billion Dollar bailout of Citigroup into common stock, but that our tax dollars may go to buy up to a 40% stake in the insolvent bank.  Mike Shedlock has done an excellent analysis of the report, and Barry Ritholtz has also noted that we are proposing to throw good money after bad.  Best of all is Karl Denninger's analysisposted on his blog.  Henry Blodgett had joined the debate as well pointing out that at current valuation converting the taxpayer's $45 Billion preferred into common would result in an 80% stake not a 40% stake as the insolvent bastards propose.

Taking another stake in the bank is a bad idea.  Throwing more money at the bank will not work.  How much more will the government commit waste of our tax dollars?  More than the whole is worth?  If you or I had an old family car in need of repair, we would look at the cost of repair in relation to its market value.  No prudent man would pay more for repair than the item is worth.  No government should spend more to fix a problem than the problem is worth.  Citigroup's current market value - the sum of the outstanding shares of the enterprise is approximately $12 Billion.  Does adding $40 Billion to the enterprise make sense?  More than 3.5 times its cost?  For an insolvent company that is ready to be taken over by the FDIC?  Where is the prudence?  See for yourself.  Here is Citigroup's chart:

Either liquidate Citigroup because it is insolvent, or nationalize it to preside over an orderly liquidation.  Just don't waste more money trying to save an insolvent bank.  We roundly criticized Japan for maintaining zombie banks during their 20 year depression.  Why should we follow in their footsteps?  There is going to be paid either way, but the question is whether the pain should be quick and deep to get it over - which will hurt most those with a financial stake in the bank (stockholders and bondholders), or should we drag the pain out slowly, every day watching another crisis, spending taxpayer dollars with another bailout and spreading the loss and pain to the entire nation over 20 years.   Neither solution is good, but my vote is to make those that took the risk and benefited from the gain to take the loss.  Not the taxpayer.  Short term nationalization of banks now is what is needed to liquidate the banks and purge the rottenness out of the system.  Only when we have rid ourselves - through bankruptcy or the equivalent - of these insolvent banks will we be able to recover the economy and start the growth cycle anew.

Oh and by the way, its time to move your money to a local community bank that you know is solvent.  The return to Main Street is underway.  Do business with people you know and trust.

Hold Those Responsible Accountable!

Outright bank fraud and fraudulent and reckless banking practices contributed to the current economic meltdown.  Everyone involved in the process - from the borrowers to the brokers to the bankers to the underwriters and ratings agencies - should be held accountable.  How?  Existing fraud laws are sufficient, but Congress should expressly authorize private individuals to pursue these bad actors for a cut of the recovery.  Authorize the public to bring the equivalent of a qui tam  action in the name of the People of the United States against those  involved in this massive fraud and reckless conduct.  Until these individuals are pursued, the country will not be able to put the crisis behind and will not be able to have faith in the markets or banking system.   

As we well know by now, borrowers falsified mortgage applications to get loans they could not repay in order to buy houses they could not afford.  Mortgage brokers assisted and guided these borrowers into lying in order to get qualified so the mortgage broker could get a commission from the banks.  The banks, in turn, knew and understood that they were approving loans with less security and lower ratios than they usually required, and they knew that noone to that point had verified the information on the mortgage applications.   Knowing these loans were substandard, the banks packaged the mortgages for sale and colluded with the ratings agencies to give the collective pool of loans a higher rating than the individual loans in that pool deserved.  That was only the start of the chain, but that chain is oozing with culpability.

Instead of bailing out the banks that were at the very least collusive with the reckless conduct and/or using my tax dollars to pay my neighbor's mortgage, spend the tax dollars to pursue and hold accountable those truly responsible or authorize the private sector to do so.  Create an army of private attorneys general to pursue those who participated in this fraud.  Start with the borrowers who lied on thier applications.  Not all borrowers lied on thier applications and not all borrowed beyond their means.  Recover what you can from the ones that are culpable and leave the rest alone.  Some estimates are that these liars are less than 8% of the mortgage borrowers.  Hold these thieves accountable!

After ferreting out the dishonest borrowers, use discovery or whatever practical leverage can be applied to encourage the lying borrowers to identify the mortgage broker involved and the process used.  Then pursue the mortgage brokers.  With a vengence.  Like borrowers, not all mortgage brokers are evil.  Many were actually doing a great job placing legitimate credit with lenders.  As an aside, it is a shame that the governments are moving to over regulate the mortgage brokerage industry based on the fruadulent actions of a relatively small minority.  Focus on the small minority of mortgage brokers.  Discover how the brokers encouraged (or misled) borrowers into misstating accurate information on their application.  (Did you ever use a mortgage broker - you filled out forms by hand and they input the numbers into the computer on their forms - - the trouble is the broker never put the same numbers onto the form - - but I digress.)  These brokers were instrumental in perpetrating the fraud.  Either they failed to input the correct information in order to fudge the numbers, and/or they encouraged the borrower to misstate their financial information and/or they turned a blind eye to obviously false information.  Ferret these brokers out and recover from them the money defrauded out of the system by these loans.  Hold these thieves accountable!

 Don't stop at the mortgage brokers.  The fraud gets worse and the pool of wrongdoings is not empty.  Go after the executives and everyone in the chain at the banks who recklessly or intentionally encouraged the mortgage brokers to lie.  There is a now famous "Cheats and Tips" memo from Chase that circulated instructing its brokers how to lie on loan applications.  (Isn't that bank fraud?)   Many more examples will surface if we stop protecting those responsible and hold them accountable.  Hold these thieves accountable!

There is further to go too!  We have the ratings agencies that packaged and sold these junk bond grade assets as the highest grade assets.  That is fraud too.  It isn't just an errant opinion on value, it is systemic fraud.  Hold these thieves accountable!

Authorizing private actions and an army of private attorneys general will remove the burden of prosecution from the government and remove the recovery from the spectre of government corruption.   Part of the problem with arresting the downward slide of the economy is that noone has any faith in the system - with good reason.  It was a rigged game.  Until the government is willing to prosecute the people that raped our banking system with fraudulent and reckless practices to line their own pockets, no faith will ever be restored in the system.  (With all this fraud out their, maybe we should just forget about authorizing private actions and use the stimulus money to hire every attorney out there to purse the perpetrators - nah  - we need the private attorneys general. ) 

They Still Don't Get It

Wall Street bankers just don't get it.  The ill-guided stimulus spending bill contained a provision limiting salaries of the top 25 earners at banks that receive TARP funds (federal bail out money).  These banks are complaining that it is unworkable and will result in the loss of their best and brightest talent.  The New York Times quoted an unnamed HR executive at one of these corporate welfare recipients

 "To be put in a situation where you're limiting performance-based compensation is the dumbest thing you can do," said the senior executive at the investment bank. "Everything that shareholder advocates have been seeking for years is thrown out the window."

Another consultant was postulated of a coming brain drain.

What Wall Street doesn’t get is that they are insolvent and they can’t keep paying the salaries and bonuses in the manner they have when they are broke.  It would be one thing if they didn’t take taxpayer funds to do what they did, but when the government provides our money to help them, the recipients are obligated to spend the funds wisely.  Excessive compensation is not wise. 

Frankly, letting the banks fail is a sound choice, but our government doesn’t have the fortitude to let the banks fail.  Instead, we are keeping them on life support with TARP money.  If we are in essence supporting these banks, all the employees should be put on the government service pay schedule.  Especially the executives.  Limiting the salary and bonuses of only the top 25 earners is a gift.

Finally, a brain drain at these banks is not such a bad idea.  It these highly prized geniuses that created the opaque investment vehicles, gamed credit default swaps, and made loans to people who couldn’t repay the obligations, who got us into this mess to begin with.

Nationalize Banks Now

The discussion topic for today is whether our government should nationalize our insolvent banks, rather than continuing to bail out these same banks with taxpayer money so that the people in control of the banks - those people who made the bad business decisions that caused the insolvency in the first place - may continue to preside over those institutions.  The proposal is to allow the government to take over the banks, rather than bailing them out, and to oversee the  orderly liquidation of the banks, while at the same time maintaining the flow of capital into our economy.  A necessary consequence of the nationalization is that the holdings of the banks investors and stockholders will be wiped out.  Part of the orderly liquidation would require the government to hold onto bank assets for a short time in order to re-privatize them once the core of the current economic crisis passes.  

No bank is too big to fail.  The question is whether we have a system in place to assist in an orderly liquidation of failed institutions.  There can be little doubt that our existing institutions (bankruptcy courts) are ill equiped to handle a systemic failure.  Policy decisions need to be mixed with the liquidation.  The same principles that apply to ordinary liquidations are the same; however, the tactics and rules need to be different.  A take over by the government is not perfect, but it is more pallitable than paying huge bonuses and salaries to the people who let their banks fail.  

Continuing the bail out philosophy helps neither the businesses nor the economy.  No government is big enough to stop business cycles either.  The laws of supply and demand control the economy.  When the banks extend credit to borrowers without regard to whether they can repay their loans, it is those banks, their investors and their stockholders that must suffer, not the taxpayers.  When the borrowers as a whole decide (or circumstances require) that it is time to pay the piper and reduce their debt burden, aggregate demand will slacken.  No government manipulation of the banking system will increase demand.  Providing more liquidity will not improve the credit worthiness of the borrowers.  Buying bad loans at above market prices will not affect demand.  Essentially the government bail out and bad bank proposal is nothing more than encouraging the banks to continue to make bad loans to consumers and businesses that cannot afford to take out any more credit.  

What is left is a realization that Bernanke's and the US Government's efforts to avoid a credit collapse and a shrinking economy are nothing more than an attempt to shift the burden of loss and pain of recession from those who assumed the risk (and profited therefrom) to the taxpayers and the workers.  The saving grace is that our economy is strong and commerce will continue once supply and demand are balanced.  Business cycles need to happen.  If banks collapse and are liquidated, there will be new lenders that arise out of the ashes.  The new lenders will learn from the mistakes of others and lend in a more prudent fashion (for a short while anyway).  Cars will continue to sell, albeit at a lower volume, and new mnaufacturers and new dealers will take over where old ones failed.  If we let our government debase our currency and squander our resources to maintain businesses that could not anticipate business cycles, we encourage poor and non-competitive behavior.

Will there be pain from failure?  Of course.  The question is who is in the best position to bear that pain?  If we spread the pain across society, then any recovery will take years.  That is the legacy of FDR and the Great Depression.  It is the legacy of Japan's lost decade.  Liquidate now and watch a healthy new economic phoenix arise from the ashes.  Perhaps Andrew Mellon was right afterall.