Has it really been only three weeks since Inauguration Day? Only 21 days since the world stopped to listen and cheer as Barack Obama declared that "there is nothing so satisfying to the spirit, so defining of our character, than giving our all to a difficult task"?
Then, the new U.S. President's message gave hope. Today, his new Treasury Secretary, charged with the character-defining, Sisyphean task of fixing America's banks, gave one of alarm. Check out the language Timothy Geithner used: "[W] know that the cost of a complete collapse of our financial system would be incalculable for families, for businesses and for our nation."
If Mr. Geithner aimed to shock, he succeeded. If he wished to provide hope that he has the solution, he failed. The plan is long on good intentions but short on specifics. But the biggest single problem is that it contains a lot of talk about how to remove toxic loans from the banks, but none about removing toxic banks from the economy. That was one of Henry Paulson's big errors, too.
Mr. Geithner promised more cash for struggling financial institutions. Before they get money, some of the biggest ones will have to undergo a "stress test" to determine how healthy they are.
But he isn't the only one using medical metaphors. What's lacking in the Geithner rescue plan is a process of "triage," says Alex Jurshevski, a veteran banker and restructuring expert who runs Recovery Partners, which manages distressed financial assets.
Meaning what, exactly?
"Meaning that the weak institutions are not killed off quickly, as must happen in these situations," says Mr. Jurshevski.
In short: the government and its financial regulators must decide which banks should survive and which must be left to die. The latter group can either be shut down and liquidated or nationalized. Either way, their shareholders would wind up with nothing, which is only right.
It makes a farce of the system to have Citigroup lumbering around with an $18.3-billion (U.S.) market cap when it can never hope to earn enough to pay back what it owes the U.S. government. Citi is broke. Without $50-billion in cash supplied by the taxpayer, it would have collapsed by now. Its stock-market value should be zero. And the same goes for hundreds of other, smaller banks. The Royal Bank's U.S. brokerage arm projects about 1,000 bank failures over the next three to five years.
RBC's proposed tonic is much like Mr. Jurshevski's. "The sooner the bank regulators can shut down the troubled banks," write its analysts, "the faster the industry will get back on its feet, in our view."
It isn't complicated, which isn't to say it's easy. First, the government seizes the insolvent banks; then it sells off any good assets, along with the deposits, and shuffles off the lousy assets into Mr. Geithner's new "bad bank," to be liquidated over time (at some cost to the taxpayer, no doubt). That's similar to how the U.S. government handled the savings-and-loan crisis, and how Sweden mopped up after its early 1990s banking bust.
"As long as you have banks that have a whole different view of the world because [they're]not solvent, where everything you do is directed to keeping them solvent, you have banks that are very detrimental to the system," said Bill Seidman, who knows a thing or two about the subject: when he was chairman of the U.S. Federal Deposit Insurance Corp. in the late 1980s and early 1990s, he handled more than 1,000 bank failures.
This approach doesn't have to be pure economic Darwinisim. The Obama administration can, and will, put capital into relatively healthy banks if required. But killing the shakiest banks has several advantages. It sets the right incentives for future generations of bankers ("If you behave recklessly, you will lose all your equity. Not just some of it - 100 per cent of it.")
It clarifies who the survivors will be, making it possible for those banks to get new capital from private investors on more reasonable terms. Most important, the process of buying the quality assets and deposits of insolvent banks, the way JPMorgan Chase bought the remnants of Washington Mutual, can strengthen the solvent ones.
And that's the point of the exercise, remember: not to start up a "bad bank" in Washington, but to create a bunch of "good banks" around the country that can lend with confidence again. Mr. Geithner's plan will be judged on whether it can achieve that. It looks like he missed the mark.