US and along with it the rest of the world is facing a severe credit crisis today. A large number of banks are facing credit crunch and are at risk of a being put through a "run on the bank" and a susequent collapse. Some of these banks are too big to fail. If they fail then they will have a domino effect and result in other bank failures and trigger a collapse in the economic activity by credit freeze or a cardiac arrest of the banking system.
What should the government do? Should it stand by and watch the destruction of the market system until inflation reaches 2000% like Zimbabwe or do something to stop the bleeding and stimulate the system back to normalcy?
The government is the ultimate god father of our era and government should bring confidence to market place so that economic activity goes back to normalcy. How should government intervene ?
Should government be stupid enough to buy all the CDS ( Credit Default Swaps ) and derivatives which has no value and socialize the losses of the banks ? No absolutely not. Should it listen to a ex CEO Goldman Sachs for advice on rescuing wall street. No way! even eight graders should know better than that.
If financial system needs capital then governmet should provide capital by buying equity positions in the trouble financial institutions or like Warren Buffest negotiate a sweet deal with the troubled banks to get equity at highly discounted price.
lets take an example:
If Bank of America need 80 billion to write off bad loans then government should give it 80 billion but not by buying toxic derviates but by buying equity in Bank of America. This gurantees that government is buying a stake in the pofits and losses of the bank and is essestial providing gurantee that the banks won't fail which sould be good enough to restore confidence in the bank.
Let government buy into all major troubled banks and save them from credit crisis but it should never be stupid enough to buy only the bad loans at higher than market price instead it should get an equity for every tax payer dollar it spends.
It would be useful for our "god father' or the government to get out the market system in long term future when the markets starts to function again so that banks can be free to do what's best for them and government can focus on its core functions of national security, law and order, protection of enviornment and investment in human development and sciences which usually don't find any private investment.
I hope government would be smart with the tax payer money and not socialize private sector losses.