Over at the Telegraph, Evans-Pritchard points out that UK banks have 4.4 Trillion dollars in foreign liabilities – twice the size of the UK’s entire economy.

He argues that:

We cannot even do what Iceland did to save its skin. Reykjavik refused to honour the foreign debts of its buccaneering banks. It let them default, parking the losses in Resolution Committees. Small islands can do that. Iceland has fish instead, and lots of metals.

Britain cannot follow suit. The debts are too big. If London takes such disastrous action it will set off global panic and lead to an asset death spiral, drawing the entire world into deep depression.

 He ladles out blame (correctly, imo):

What have our leaders wrought? The reckless conduct of City, the fiscal incontinence of Gordon Brown (3pc deficit at the top of the cycle), and the pitiful regulation of the UK housing boom have all combined to bring the country to the brink of disaster.

And the blame he ladles, I think fits exactly with the US – the reckless conduct of Wall Street, the fiscal incontinence of George Bush, and the pitiful regulation of the US housing boom have all combined to bring the country to the brink of disaster.

Obama appears to have settled on a "bad bank" as his next step in "solving" the problem.  What the bad bank will do is buy up distressed assets held by financial institutions, for more than they’re worth (no point in buying them at market prices, that’s what everyone’s trying to avoid).  They will keep those assets in the bad bank and sell them when they’re worth more.  The reason this is necessary is probably that the Fed, which is holding many of these assets right now as collateral for loans, needs to either get them off its books or sell a lot of bonds (or officially create a lot of fiat money).

This amounts to another giant transfer of wealth from the average American to the US’s financial elites.  During the years when they were "making" record profits through the old fashioned method of fraud, they paid themselves record bonuses.  Now their losses will be largely paid off by ordinary Americans, while they keep the bonuses they earned in the so-called good years.

It is quite likely that the financial sector as a whole, after losses are apportioned, did not actually make any profits in the last ten years, and in fact destroyed a great deal of wealth in an orgy of losses.

Moving the debts around does not get rid of them.  They still exist, and they must still be paid off.  It’s just that instead of the people who caused the losses and earned the huge salaries and bonuses being wiped out, instead of stockpayers being wiped out, instead of those who loaned the money to financial institutions being wiped out, the pain is going to be spread over the entire economy.

Odds are you never saw any of the good years, most Americans didn’t.  But you’re sure going to pay for the hangover.

Some socialization of these losses is necessary, if only to stop a cascade effect. But that should occur after the stockholders have been wiped out, after laws have been written requiring claw backs of compensation based on earnings which were fraudulent, and so on.  At the same time tax loopholes allowing money to be taken out of the country need to be closed and marginal tax rates need to be increased.  Why?  Because at the end of the day the class that benefited from the last 8 years was the very rich – the 1 percenters.  Even with laws to try and claw back the profits, those who benefitted the most should be forced to pay the most to clean up the mess they created.  

90% marginal tax rates on all income over one million would be a good start.  Not only would it put the bill for this mess on those who made and benefited from the mess, it would make it much less likely that another fiasco will ensue.  As long as executives and key money managers know that in a four or five years they can make enough money so they’ll be rich for the rest of their lives, they will always be willing to engage in risky activities and outright fraud, so long as they figure they can get away with it for a few years.  Fail to make it impossible, and it will happen again, especially as it has now been proven that when it all blows up, the government will step in and pay most of the losses. 

Privatize the profits, socialize the risks means that what happened will happen again.  It’s not just about "regulation", it’s about incentives.  Fixing regulations alone, even assuming it’s done properly, will not prevent a repeat.

It’s unclear the economies of either the US or Britain can survive the current mess, especially if it continues to be mishandled.  They certainly won’t be able to handle a repeat.