We’ve talked often on this blog about the necessity to have confidence in the banking system. Paper money is, after all, just paper.

There’s no point playing the blame game. It’s all about what we do now.

Although G7 and the IMF have gone to full battle stations the reality is the die is cast. Markets have crashed, liquidity has disappeared, credit is history and the revaluation and squaring up of positions has to somehow be undertaken.

The margin calls will be coming thick and fast next week. The derivatives nightmare is a beast matched only by the legendary Hydra. Each cut brings forth two new disasters.

The choices facing policymakers are stark and , for them, almost unbelievable.

- Public interest free money will need to be pumped into the system. Not to cover debts but to provide a boost to a money supply which is disintegrating as loans are written off. This should not be a bank bailout but a reconstitution of a money supply from the public. Banking for now is suspended and banks are likely to be worth very little unless they are very well capitalised and have little exposure to falling asset prices. Bank deposits will be uncondtionally guaranteed under this approach.

- Stock markets: Next week will see a wave of selling that can only be described as a death spiral. It is hard to see any approach other than freezing all global stock markets. The alternative is for governments to start buying stocks i.e. nationalisation of business. That would be a very big call but is possible.

_ Currencies: There are potentially very crazy moves ahead. Deficit countries will see huge sell offs so some kind of coordinated intervention will be needed here. It may not be physical but more a guarantee between creditor and debtor nations to maintain current levels.

This is going to be a momentous week. Let’s hope policymakers are up to the task .

Either way

There seems to be some suspicion around the Fed’s balance sheet at the moment and questions are beginning to be asked about its capital adequacy.

It’s dolling out cash like sweets at a birthday party. Where is it all coming from?

Last week bank borrowing from the Fed reached an average of $188bln a day!!

All the primary dealers (all 3 of them GS, MS and ML) were in at their teat, the Primary Dealer Credit Facility, for over $100bln.

This is the stuff of legend.

Parker Brothers will be rushing out new Monopoly sets soon with an extra 6 zeros added.

To say the banking system is on life support would be an understatement. Its actually getting CPR……one billion, 2 billion, 3 billion…………

Even the Fed must run out of cash at some point.

Sure the Treasury can sell more paper….but whoa……who is going to keep funding the US Treasury in order to buy toxic paper from the banks?

Who will bail out the Fed?

A whole week drifts by and as yet no signed bailout deal is on the table.

Let’s be clear about this: it isn’t going to work. Nothing less than a full recapitalisation of affected banks and financial insitutions will suffice. Repackaging bad debts has been tried already.

What should happen is a debt for equity approach. As it stands now equity holders have (and should be) absolutely wiped out. They have done their dough.

But the real sticking point is all those bondholders. Bonds rank ahead of equity in a liquidation but to avoid that bond holders would swap debt for equity: yes its a disaster scenario but it allows balance sheets to be reformatted (esssentially this is a reformatting of numbers on a spreadsheet).

Given the leverage in debt markets the value of the equity will be piddly but there is not a lot of choice.

There is no one taxpayers should be bailing out failed institutions.

The only solution for taxpayer involvement is complete nationalisation of failing institutions without any fancy deals.

The half way both up approach will not make anyone happy and merely patch up a badly flawed system.

Who could forget the electrifying performance of Michael Douglas in “Wall Street” a film that still smolders in the consciousness as reflecting the canvas that is the financial market.

Though the products have changed the mantra hasn’t: Greed is Good.

Greed as an incentive to productivity? I don’t think so. Look at the innovation coming out of the technology world and compare it with the innovation coming out of the financial world. Technology is founded on the idea of making life easier, efficient and fun. Innovation in finance is a way of slicing and dicing the same piece of paper.

But what’s the paper made of? Not much really as we are finding out.

The investment banks that rolled out of the 80s and dominated the global financial landscape are falling like dominoes. Falling on the back of injudicious management of risk, capital and balance sheets.

But that’s not where the rot really starts. Greed is just another human emotion, another desire. Living in a world with few boundaries it should come as no shock that we have tipped over into the abyss.

The money seems to have been flowing like the pump was turned on full steam, an inexhaustable supply of cash to be invested in anything that moved or, in the case of property, did nothing.

Now the party is well and truly over. After numerous attempts to keep it going by the self proclaimed master, Alan Greenspan, no one can take anymore. Its like turning up to a mad all day party at 4am with another case of wine or keg of beer. It has no value. Everyone is asleep, passed out.

It will take a while to play out. Some more institutions will go under probably in the form of a shotgun merger, a hastily arranged monetary marriage with glum faces standing behind the bride and groom attempting to be happy.

Just last night the FSA in the UK talked about how “well capitalised” HBOS was. At the same time they were forced into a “merger” with Lloyds. Oliver Stone couldn’t make this up if he was on acid.

But looking ahead can we find anything in the rubble to work with? Well maybe.

It’s time for a reform of the banking system, root and branch.

Banks can go back to being deposit takers and loan makers (though I think P2P lending will eventually take this over).

A Parliamentary institution can take over the task of supply money to the economic system via a Universal Basic Income and Direct expenditure. This would be managed with excrutiating process and targets.

Not like our current Central Bankers who have given up on targetting inflation: one because they can’t get it to work and two because they are more worried about the impact on financial markets.

It doesn’t work. The current system promotes inflation, falling real wages and the treatment of money as a financial asset.

So when we see the reaction to Parliamentary control of the money supply we can simply point out the failures of the private system for all to see.

I had heard that some Euros were better than others and this story confirms the rumours.

Germans are refuisng to accept Euros which have originated from the Latin Bloc, especially Italy. They want “hard” Euros issued by the almighty Bundesbank, that inflation fighting automaton. You can hardly blame them given the fiscal history of Italy, never mind Greece, Spain or Portugal.

But what this shows is the lengths to which people will go to mitigate risk. It seems a waste of time really given that the Euro is universal in its value and acceptance. But its a bit like English and Scottish Pounds. No one ever wanted a Scottish one even though they were both accepted as legal tender by the Bank of England.

Perception is everything and the Germans have long memories of inflationary times.

The sad fact is that if the financial system falls apart nothing will save you. Having a nice pile of gold soveriegns might but the reality is that there wouldn’t be enough to create a reasonable market for exchange. Now a nice veggie garden is more of a goer in times of monetary distress. This is where NZ has a major comparative advantage. Nearly everyone has a patch of dirt in which to grow stuff.

Our central banks have a lot to answer for but promoting home grown veggies is one good thing to come out of this debacle.

After a 1200 pt rally in the Dow the market has come to its senses and started bailing again. It’s a year now since Bear Stearns stumped up $3bln plus to bail out one of its funds thereby signalling the start of the crisis.

The news is bad wherever you look but the focus now is on the banks and whether they will be able to shore up their balance sheets which have more holes than a block of Emmental.

The pressure of continued write downs will simply hasten the inevitable collapse of a major institution. The big question is how the banks will be re-capitalised.

The first wave of capital provided by overseas investors has resulted in major losses and burnt fingers. Sovereign funds may be a little more wary this time round even if the price is way cheaper.

The Naked Capitalist reports on discussions the Fed has been having with private equity companies to see if they might be interested in stumping up some cash. However, there are issues of bank ownership and the size of stake any non-bank organisation can take. The word is that the Fed could seek to relax these rules.

This does not fill one with confidence.

Closer to home NZ finance companies are collapsing like a house of cards. It’s hard to know if any will be left. Already prosecutions are underway against accountants who signed off on the books of failed companies. I wonder how bank auditors will be feeling when they come to sign off the books of the major banks and see a long list of assets “uanble to be valued” properly.

There should be caveats galore.

But the question remains as to whether the crisis will spread to the major banks. If it does we could see queues around the corner of all our financial institutions before too long. I’d certainly advise people to have a bit of cash set aside and money spread around various banks. Having said that NZ is one of the only countries in the OECD not have have deposit insurance for banks.

Given the central banks moves so far it’s safe to say the banking system is underwritten to some degree but if you own shares in a bank i would be very uncomfortbale about that.