Welcome on board, Paul ...

Because Paul Krugman seems to agree with me (and links therein) on the main issue, let me discuss a few points he does not mention explicitly or ignores altogether.

1.It is not true that this Administration is "dithering" and choosing "absence of action" when approaching the financial crisis. The Obama Administration has a plan: it is the same the GWBush Administration had. It has been in place for more than a year and half now: keep the banks alive by feeding them public money. Earlier on they thought - rather incredibly, given that, theoretically, the Fed should know what is on the books of the American commercial banks, which is an issue we also should raise, Paul :-) - that just cutting interest rates and making liquidity abundant by discounting whatever kind of securities the banks had in their portfolios, would work. Well, it did not as we have painfully learned, and a year a half later - yes, ladies and gentlemen: "they" have been working on it at least for the past 18 months ... the mess, in fact, started almost three years ago, but at the Fed they were busy doing research on something fancier - most large American banks are not only "bleeding", they are paralyzed. In the meanwhile, we have pumped hundreds of billions of dollars of public money (Fed's money is public money) in their vaults, part of which has been cashed in. And we intend to keep doing it for as long as public opinion allows us (well, them) to continue doing. That's the strategy, Paul, and I see no "absence of action" here.

2. At the core of this continuous bleeding are derivatives. Because neither the Fed nor the SEC nor any of the "regulators" involved with the problem are making information publicly available about the portfolio of credit derivatives banks are sitting on, and its evolution, one can only guess. My guess is that only a small percentage (20-30%) of the outstanding $60 trillion has been written off in a form or another: most players are sitting tight on their bets. The strategy is simple: because my counterparty cannot pay, there is no reason for me to execute the contract, since by so doing I can send the counterparty into uncontrolled default. Let's sit on it, agreeing on some convenient (for the counterparty and me) mark to market: nobody can tell what it is worth, as there is no market in any case. Should we get lucky and public money become available, as in the case of AIG - by the way, the numbers in the NYTimes article about AIG are way too conservative - I can try cashing in. From the taxpayer, obviously, as my counterparty will just act as an intermediary.

This is the beauty of the situation, which too many pretend not to understand. Before the crisis a derivative was a zero sum contract: I win, you lose, and viceversa. Once the crisis broke out, it became a negative sum contract: I win and we both lose, because you default on your commitment. After the government "bail out" plan(s) came into effect, derivatives (at least those written against the big players) have become positive sum contracts: I win and you do not lose, because the taxpayer will pay. It should be clear to anyone that, as long as THIS is the plan, troubled banks will sit tight on their portfolio of derivatives and make the public purse "digest" them one at a time. It is not in the self-interest of the current management of troubled banks to get the economy going again. Their self-interest is served by avoiding insolvency (to keep their position and salary) for as long as possible. Unfortunately, that's the opposite of everybody else's interest!

One, additional, social gain from "temporary nationalization" of the big players: we could net out a few trillion dollars of credit derivatives.

3. Not only will the stimulus have no effect whatsoever as long as the banks have not been fixed (I am pretending I believe in the multiplier like PK does, here) but NOTHING will have any effect if the banks are not fixed. Tax cuts will have no effect, as no new businesses will open to hire the unemployed workers if there is no credit. No market mechanism will, in fact, work: no matter how much relative prices change, how do you shift resources from activity X to activity Y if the financial system does not intermediate the move?

4.Which is why Alan Blinder's arguments against nationalization are not convincing. Let's see briefly why.

• "Where to draw the line". Things are the other way around: it is the current policy that puts the sound banks at risk. They invested wisely (i.e. taking less risk and accepting lower returns) and are now unable to reap the benefits of that strategy as the bad banks are kept alive by public money. Not only, the latter have access to super-subsidized loans, whereas the good banks have to compete on the markets to raise funds and (contrary to those on the Fed Funds) the rates on other sources of liquidity are much higher because spreads are higher. Hence, the longer the current policy continues, the worse the situation is for the good banks as they cannot gain market shares and, to compete with subsidized banks, they are forced to make loans at rates lower than the market prices them.
• "Domino effect". No domino effect whatsoever. The market capitalization of the truly distressed banks is negligible already: stockholders have already lost their investments and it is most unlikely that rumors of nationalization may increase their despair. Beside, nothing prevent the Administration to pass legislation allowing the FDIC to "purchase" the failing bank from its shareholders at the average market value of the last few weeks..
• "The management challenge". Come on, are we serious? Do we still want to stick with the myth of the superbankers who cannot be replaced, who are the only people on earth who understand the business and are so smart and specialized to justify the insane wages they have paid themselves? After these results? Professor Blinder, you must be kidding. Given WHAT needs to be done here, there are a few thousands (say 4-5 thousands) excellent financial and banking economists in the financial industry itself, in the Federal Reserve system and even in academia, who could be recruited for the job. Just think of all those good bankers who managed the sound banks properly during these years: don't they deserve a chance to run, say, Citi?
• "Political obstacles" and all that. Well, that's politics, which is where the problem is. Certainly, as long as plans are not made and actual implementation not considered, time will pass and things will become progressively more difficult. Given that responsible political figures from the GOP are starting to speak in favor of letting some banks go (a proper change of direction away from subsidizing everyone in troubles MUST involve a judicious mix of letting some banks go while taking over some other), the political environment is far from rejecting a-priori a seriously designed change of strategy. That the current one - which I insist dates back from the days of GWBush - is not working and costing us enormously should be clear by now.
• "Nationalization" is not acceptable by the American public opinion. Let's stop fooling each other: "nationalization" is what the FDIC did with Washington Mutual, and dozens of other banks! That's what FDIC is for and, if it needs more funds, they can be provided exactly the same way that abundants funds were provided, to be wasted, to the Treasury via TARP I and II. What is important, instead, is to write into law the commitment to give the banks back to the taxpayer once the cleansing is completed. Once taxpayers become certain that the recapitalized banks will be given back to them in proportion to the taxes they paid, I am pretty sure they will not worry about "nationalization" at all ... quite the contrary, in fact!

What makes the "anti-nationalization" position insane, from a social point of view, is that on the one hand we are already paying its price and, on the other, we may soon be forced to carry it out in a condition of emergency, which would be much worse.

On top of everything, here is the most important factor: as long as the insolvent and paralyzed banks are not replaced with solvent and functional ones, possibly many "ones", the recession will get deeper and deeper, the stock market will keep collapsing, corporate America will continue to self-destruct and, with it, our jobs, our productive capacity, our growth potential. Six months from now, if this trend continues, we may be into a great depression for real. And we will have, once again, only our politicians and their "political priorities (and allegiances)" to blame.

P.S. Some of my libertarian friends may believe I have gone nuts advocating temporary nationalization. Maybe I have gone nuts, but their arguments do not convince me. They are based on principles that ignore actual reality: right now the state IS controlling the banking system and IS pumping hundreds or billions of taxpayer money into the banks. The differences with actual take over are that, under the current policy, (i) there is no end in sight to the waste of public money, (ii) excutives and managers that have mismanaged the banks are not made accountable, and, (iii) should this policy continue, the financial industry will emerge even more concentrated, monopolistic and anti-competitive than it was when the crisis began.

Taxpayers are paying dearly the insurance against the "aggregate risk" financial firms stupidly undertook. It is only fair that the taxpayers become the new shareholders of the financial system's firms and decide who their new bosses should be.