The financial crisis is the greatest threat to the U.S. economy. The right thing to do is to apply the principles of responsibility and competition, and the lessons of history to get this right. The most important lesson is that failed, insolvent banks cannot be permitted to continue to operate using taxpayer subsidies. Letting these "zombies" walk the financial system was at the heart of the savings and loan crisis and the slow Japanese recovery from its financial crisis. These institutions should be taken over, their management and shareholders made to suffer the consequences of their failure, and the assets re-sold to private sector entities as fast as is feasible. That's good policy: discipline failure, promote real competition, and use assets effectively in the private sector. Yes, it will be costly - but not more costly than continued propping up of failed big banks. And, yes, it will raise the specter of "nationalization," but it is really about re-allocating financial assets in the private sector. The bottom line: no more taxpayer resources without real use of discipline and effective workouts.
The truth is that the Bernanke-Geithner plan - the plan the administration keeps floating, in slightly different versions - isn't going to fly. Take the plan's latest incarnation: a proposal to make low-interest loans to private investors willing to buy up troubled assets. This would certainly drive up the price of toxic waste because it would offer a heads-you-win, tails-we-lose proposition. As described, the plan would let investors profit if asset prices went up but just walk away if prices fell substantially. But would it be enough to make the banking system healthy? No. Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they're needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don't need or deserve to be rescued. And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it's just not going to happen.
Holtz-Eakin's a conservative. Krugman's a liberal. The Obamans are "pragmatists." How can the ideologically grounded understand the crux of the financial crisis, but the "postpartisans" cannot?