If the government is taking equity stakes only in institutions that are deemed to be at risk, will you? Will anyone? Or will this, then, end up as more good money following bad?

Fareed Zakaria thinks the current crisis might teach people like me a lesson. Perhaps he’s right (in my case, he’d better be!) – but he also thinks it will teach government to live within its means – a wildly optimistic conclusion that I see no basis for reaching…

But it’s the demonization of the markets that we see in so much of the rhetoric – from the left, and God help us, from the right – that is troubling to me.

From the left, it’s kinda expected. From the right, it’s particularly jarring, and rather more disturbing.

I like the equity stakes better than the initial Paulson Plan, too – which, as you know, I strongly opposed from the very beginning. Why? Because the equity stakes show an inherent faith in the market to eventually right itself after the turbulence passes – if we didn’t think things would turn around, the stakes wouldn’t be any good…

I agree.

And, moreover,

* it doesn’t require figuring out how to price these abstruse “toxic” securities that Paulson was going to (and may still) buy.
* it doesn’t undeservedly reward the current owners of those securities (by paying above-market prices for them, which was surely the intention).
* it, as you say, gives the taxpayers a positive stake in the upside.
* it does (effectively) punish existing shareholders by diluting their ownership stake. The Government now owns 80% of AIG. Which means that the previously-existing shareholders now own only 20%. When the Government eventually sells its shares in the company, the price/share will be much lower than it would have been if all those new shares had not been issued (i.e., if they’d just given AIG a handout). Of course, those shareholders will still be better off than if AIG had been allowed to go bankrupt (in which case, they would have lost everything). But, I think correctly, the collateral damage from allowing that to happen (at this particular point in time!) was deemed to be too great.

There have been so many interventions at this point that I don’t even know which intervention to address – but I’ll meet you part of the way: of the interventions on the table, the one that makes the most sense is certainly the recapitalization of troubled financial institutions through equity stakes. Had that been the call from the beginning, we might not be having this conversation.

Had that been the call from the beginning, my portfolio might be 25% larger than it is tonight.

Not that I think that this is a silver bullet that would have magically cured the ailments of the credit crisis (nor do I think you have such a simplistic view)…but it’s responsive to the immediate need without being overwhelmingly reckless re: the American taxpayer…

To pick, but one example, the 3-page Paulson plan was a friggin’ joke. If I want a $10,000 grant for a small research project, I need to supply a more thorough and well-thought out document than they proffered with their request for $700,000,000,000.

Strictly amateur-hour, and it reeked of the incompetence that has marked this Administration’s worst moments (Katrina, the mismanagement of the Iraq War, …).

But Paulson and Bernanke are not Michael Brown. They are capable of much better. And my theory is that they have been held back from acting with greater dispatch, and with better preparedness, by ideology.

Your theory (correct me if I have misconstrued) seems to be that they are simply incompetent. While the glib partisan in me would hasten to agree that every Bush appointee is to be presumed incompetent, unless proven otherwise, I think that’s not the case here.

Do you deny – and based on previous comments here, I’m pretty sure you don’t – that capitalism is one of the great goods to ever come to human society? We may wish to temper our capitalism with some socialism – but we don’t want to throw it away, do we?

No, we don’t. Which is why we can’t allow the banking system to go belly up. Sure, it’ll eventually be recreated. But, in the meantime, we’ll be back in the economic stone age.

Think of this as a disaster which, though man-made, is every bit as economically destructive as a hurricane or flood or earthquake. We don’t expect the market to take care of such calamities all by itself. We expect, nay demand, that Government intervene. I think we are well past the point where we can expect this particular crisis to pass without Government intervention.

The US has not suffered a similar financial crisis since 1929. But other, smaller, countries have. Think of Sweden in 1992, or Mexico in 1994, or Russia in 1998, or the Asian Financial Crisis in 1997. The latter is particularly apt, because there you saw a domino effect, as first Thailand, and then one country ASEAN country after another succumbed.

In each case, it required a massive intervention to set the financial system back on track.

In no case did it lead to the demise of Capitalism as we know it.

Letting markets work is messy and costly. Nevertheless, the only sensible way to deal with the current crisis is to force the companies who created the mess to bear at least some of the costs of their mistakes. Most of all, if the markets are to get back on track our regulators must put an immediate stop to their current practice of publicly demonizing the markets and work to restore confidence in the system.

That’s my position in a nutshell…

The whole story of the last few months has been about different government plans to get the banks lending again. But the market is not waiting. It just keeps saying to the big banks and insurance companies: “We think you’re carrying a lot of junk on your books, and if you don’t mark it all the way down and re-price it to what it is really worth today, we will re-price you — fairly or not.” The market is going to do what it is going to do.

So what could ease this crisis? “There is going to have to be a workout,” said the financial strategist David Smick, author of “The World Is Curved,” a book about the hidden dangers in today’s global economy. “There will have to be a restructuring of all these institutions to clean up their balance sheets and recapitalize them.” Banks and insurance companies will have to be reconstituted, merged or left to die, until these toxic assets are properly priced and off the books.

The government’s job — which it is still trying to figure out exactly how to do — will be to provide a safety net of guarantees for the surviving banks, so they will be honest about pricing their assets, and then, once they have been, to help recapitalize them. “Government’s other job,” added Smick, “is to quickly establish the new rules of the road for truth-in-lending on a global basis. We still need these kind of lending facilities if the economy is going to grow again.”

This workout promises to be painful, complicated and protracted. Government will have to do its part. But it must regulate the excesses without smothering the underlying innovative, entrepreneurial and risk-taking attributes of our economy, which are what will ultimately bail us out — as they always have.

“I have no idea what the stock market is going to do next month or six months from now,” Warren Buffett told CNBC on Friday. “I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well.”

I think the fundamental difference between you and I on this issue is this: I think the problem is going to have to work itself out through the market, and as Friedman points out, when your company is basically worthless, the market is very cruel. I don’t see that adding 10-20% on to the massive federal debt is going to ultimately be a good idea, though there seems to be a strong impetus on the part of many, including yourself, to assume that the government can steer through this crisis without massive pain if it just chooses the right path.

My view is far more pessimistic, in the short run, and optimistic, in the long run: the massive pain is coming, and you can’t stop it. But when the market finds equilibrium again, we’ll move forward into the next economic expansion…