NATIONALIZATION, NOT CAPITALIZATION.

Tyler Cowen's skeptical post on bank capitalization makes a series of fair points. Namely, Tyler asks why direct lending from the Treasury Department will fix the problem when direct lending from the Federal Reserve did little to disrupt the collapse. My understanding of the situation, though, is that it's about the nationalization, not the capitalization. Summarizing the work of Paul DeGrauwe, Yves Smith writes, "trying to recapitalize banks while the liquidity crisis is on merely throws money into a black hole. The new equity goes poof when the liquidity worries resurface (as they have, each time in more virulent form). The only way to break the cycle is for governments to take over banks, or a least most of the big ones." Or put more directly:

It is important to realise that this liquidity crisis is the result of a co-ordination failure: bank A does not want to lend to bank B, not necessarily because it fears insolvency of bank B but because it fears other banks will not lend to bank B, thereby creating insolvency of bank B out of the blue. Thus bank lending comes to a standstill because banks expect bank lending to come to a standstill.How to get out of this bad equilibrium? There is only one way. The governments of the big countries (US, UK, the eurozone, possibly Japan) must take over their banking systems (or at least the significant banks). Governments are the only institutions that can solve the co-ordination failure at the heart of the liquidity crisis. They can do this because once the banks are in the hands of the state, they can be ordered to trust each other and to lend to each other. The faster governments take these steps, the better.

You've got, essentially, a Gordian knot of problems. The banks are undercapitalized. The markets are frozen. There's rampant fear and uncertainty and mistrust. No bank can solve these problems on its own because it has relatively little knowledge of what other banks are doing or how effectively they'll operate. The coordination problem is severe. That's the knot you have to cut. Solutions that don't forcibly coordinate the banks will not succeed. And the only obvious solution that coordinates the banks is nationalization. As Steve Waldman puts it, we're in a weird moment when real capitalists nationalize.