Whilst all the focus has been on the negotitations around the bailout of the US financial system the biggest bank failure in US history passed without fanfare.

Washington Mutual collapsed on Thursday and had its assets sold to JPMorgan for $1.9bln. Not much to say really.

Over the weekend, Bradford and Bingley, a British insititution, was nationalised by the government.

Next up.

Fortis, The Belgo-Dutch financial services company, received in Eur12bln infusion from Belgium, Dutch and Luxembourg governments his morning. It’s only just out on the wires so you’ll have to keep searching for up to date information.

As credit lines dry up this will only continue. As anyone who has read John Tomlinson’s paper in the research section will know, it’s all about confidence.

If we don’t have confidence in banks then they will fail.

Why? Because our whole financial system is based upon fractional reserve banking.

Less than 3% of the actual money supply is real “cash” money. The rest is just numbers on a spreadsheet. In reality its all the same. But cash will always rank above digital money in a system which loses confidence.

Of course one can then ask what is the value of cash, a bit of paper which simply offers itself as legal tender and will be accepted in return for more of the same.

It’s clear that banks have created money to purchase assets that have fallen in value. That’s the basic issue here.

So the equity on their balance sheets has fallen.

Nothing can change that. Adding to that is the fact that capital ratios are already at historic lows so many banks are operating right on the edge. For banks like Northern Rock and Bradford and Bingley who operate by borrowing from the wholesale market it is the end.

They have no chance at all of acquiring the capital they need to function.

The solution is remarkably simple.

Throw out Basel II which is a crock and raise banks’s capital requirements.

Stablilise the system and create a more stable environment.

As Nancy Pelosi said “the party’s over”.

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?

There is no alternative.

We have no choice but to…………fill in the blank.

There is always a choice. It’s amazing that the USA, Land of the Free, seems to find itself in situations where there is no choice. We must invade, bomb, bankrupt etc. Engineer a huge crisis and then say we have no choice but to send in troops or take all your money.

Watching the negotiations over the “Mother of All Bailouts” is like watching children squabble over a bag of sweets.

But it’s dawning on many that the taxpayer should not be handing over any cash. Sure the government can stand by with liquidity infusions but any investors in banks can write off their cash immediately and that includes bond holders.

If anything this shows that there are always risks in investing even in AAA US Securities. This is a great opportunity for a huge clearout and cleansing of the financial system: making banks carry higher capital ratios would be a good start as it will automatically deleverage the system; making sure the tax system encourages productive applications of capital, away from speculative strcutures.

It doesn’t necessarily mean more regulation. Ultimately investors will have to learn more about the companies and products they invest in: what is a securitised loan, what is subordinated debt, what is a perpetual bond etc.

The rating companies are all part of the game but again new approaches will will be found to get around the conflicts of interest currently present.

Section 8 of the proposed legislation says it all:

“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

Writing out a big cheque with no strings attached is a recipe for more of the same.

Let’s hope the senators are not fooled by Tina. There’s always another way.

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.

Why do models never predict catacylsmic events? you know the ones where everything gets blown up….20 years of making safe returns followed by a complete loss of capital.

After LTCM blew up and was repackaged it seemed like no drama was too big to handle. Just reinflate, repackage, securitise and call in the delivery men. But a look at nature shows us this isn’t always possible.

We have reached tipping points before. Easter Island was a good example of how populations and resources co-exist in relationship which should be predictable but actually isn’t. When do you realise that you have cut down too many trees?

We fished cod merrily out of the Grand Banks, a steady and stable provider of cod still one day they disappeared never to return.

Now we have Peak Oil or do we? When will oil production drop off the cliff and what will that mean. Will we continue to fool ourselves into believing that there is actually an endless supply. Can we predict the outcome? I doubt it. Like the Easter Islanders we will merrily be chugging away until one day it dawns on us that its over.

We will fight it of course. However, nature is alot harder to work with than numbers on a spreadsheet. Boy we can make those up forever even if we can’t magic up fish, trees or oil.

Here’s a nice piece from Taleb, of the Black Swan, talking about our inability to forecast meltdowns. The question we have to ask ourselves is simple. Deep down do we really believe we can continue on in the same over consumptive, debt leveraged manner?

We have a great opportunity to sweep away the excesses of the last 20 years.

But try telling that to the masters of the universe. To them it’s just another hiccup in an new paradigm of economic stability.

Somehow I think they will be proved wrong again.

As if there could be any doubt about who is running US financial policy it has been announced that Goldman Sachs and Morgan Stanley will be allowed to become “bank holding companies” which will allow them access to the Fed’s discount window thus giving them an easier source of funding.

Shame Lehmans didn’t get this little gift. Then again they didn’t have anyone in the Cabinet to look after them.

It’s no surprise that a recent poll showed American’s most concerned about rebuilding their reputation overseas as their most pressing issue (83%). The country has well and truly gone down the tubes and under a Republican watch. Some mentioned National Socialism was alive and well in the USA.

Stablising financial markets is one thing but underwriting the losses of the banking system is another. This just confirms everything Thomas Jefferson ever said about the bankers and also confirms that the US is no longer the world’s leading financial center.