It is high time for some innovative thinking about how countries deal with their financial collapse and collapsing banks.

Here is a number that should cause some lost sleep. Capital losses in the United States so far totaled, according to NYU Professor Nuriel Roubini, $3.6 trillion (one fourth of America’s GDP). Of that, $1.8 trillion occurred in the banking and financial services sector. Since the total capital (net worth) of the banking sector was $1.2 trillion, this means that the entire sector is insolvent, with negative net worth or capital. (See Table below).

Under former Treasury Secretary Hank Paulsen, America has put hundreds of billions of dollars into the crumbling banks — so far, without effect. The banks aren’t lending the money, as hoped, because they need the money itself far more than they need to lend it, because their assets continue to shrink, their liabilities remain large, and hence their capital shrinks daily. Bailout money is pouring into a black bank hole.

Can history help us? No. We have never had a crisis of this nature. Even the 1930’s was different (though equally serious). Then, people pulled their money out of the banks and the banks went bankrupt; all the deposits were lost. We are not there — yet.

Let us “think different”, as Apple says. Bolivia and Poland (and Israel, in 1984) had hyperinflation — uncontrolled inflation. How can hyperinflation be stopped? We know today, because we have experience and history. It can only be stopped by ‘shock therapy’ — radical drastic measures that balance budgets, raise interest rates, inflict pain — and begin building for the future.

Today we have hyperDEFLATION. This is a new concept. We have not experienced it before, even in 1929 (then, it took about 16 months for U.S. stocks to lose proportionally what has been lost in equities in the past 12 months.) In the global economy, everything is accelerated). Hyperdeflation is a rapid collapse in asset prices, accompanied by rising unemployment, falling prices, GDP decline and shrinking trade.

How does one cure hyperDEFLATION? Same way we cure hyperinflation: Shock Therapy. Here is one version of such shock therapy. Writing in the New York Times, columnist Thomas Friedman writes an imaginary speech by newly-elected President Obama:

“Ladies and gentlemen, this crisis started with you, the bankers, engaging in reckless practices, and it will only end when we clean up your mess and start afresh. The banking system is the heart of our economy. It pumps blood to our industrial muscles, and right now it’s not pumping. We all know that in the past six months you’ve gone from one extreme to another. You’ve gone from lending money to anyone who could fog up a knife to now treating all potential borrowers, no matter how healthy, as bankrupt until proven innocent. And, therefore, you’re either not lending to them or lending under such onerous terms that the economy can’t get any liftoff. No amount of stimulus will work without a healthy banking system. So here’s what we’re going to do: We’re going to unclog the arteries. My banking experts have analyzed each of your balance sheets. You will tell us if we’re right. Those of you who are insolvent, we will nationalize and shut down. We will auction off your viable assets and will hold the toxic ones in a government reconstruction fund and sell them later when the market rebounds. Those of you who are weak will be merged. And those of you who are strong will receive added capital for your balance sheets, after you write down all your remaining toxic waste. I am not going to continue rewarding the losers and dimwits amongst you with handouts.”

This is shock therapy for hyperdeflation. It is the only bailout plan that has a chance of working. It HAS been done before. Sweden did it during their banking crisis in the 1990’s. It is what America itself did during the S&L (Savings & Loan) crisis of the 1980’s.

But will it happen? Only when political leaders understand what has to be done, and when their advisors tell them what has to be done. Shock therapy.

I think the chances this will happen in the near term are about 10%. Things will get much much worse before the real illness is diagnosed and the real cure administered.

Market Value of Leading Global Banks, Q2 2007 vs. Oct. 20 2008

Bank

Country

 Q2 ’07

Oct 20   

   ’08

 change

% loss

 

 

      $  b

        $ b

         $ b

 

RBS

UK

120

22

-98

-81.7  %

Citigroup

US

255

82

-173

-67.8

Deutsche Bank

Germany

76

26

-50

-65.8

Barclays

UK

91

35

-56

-61.5

UBS

Swiss

116

46

-70

-60.3

Societe Generale

France

80

33

-47

-58.8

Morgan Stanley

US

49

21

-28

-57.1

Unicredit

UK

93

41

-52

-55.9

Credit Agricole

France

67

30

-37

-55.2

Goldman Sachs

US

100

56

-44

-44.0

BNP Paribas

France

108

64

-44

-40.7

Credit Suisse

Swiss

75

49

-26

-34.7

Santander

Spain

116

80

-36

-31.0

HSBC

UK

215

169

-46

-21.4

JP Morgan

US

165

147

-18

-10.9

total

 

1726

901

-825

-47.8%

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