So it won't work. What's next?

When will Hank Paulson admit that his quasi-nationalization of the banking sector won't work?

Rhetorical question, I know.  But it's no longer a matter of speculation that banks will use that $250 billion "recapitalization" to shore up their balance sheets instead of lending it out.  Says who?  Well, the banks for starters.

John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.

“We will have the opportunity to redeploy that,” Mr. Thain said of the new capital on a telephone call with analysts. “But at least for the next quarter, it’s just going to be a cushion."

“I don’t think that the market wants to see that capital being put to work to leverage the business up again,” said Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt LehmanBrothers last month. “My expectation is it’s quarters off, not months off, before you see that capital being put to work.”

Jamie Dimon, the chairman and chief executive of JPMorgan, said his bank was in a stronger position to use the money than some of its competitors.

“It’s clear that the government would like us to use the capital,” Mr. Dimon said on a conference call with analysts on Wednesday. “If you are a bank that is filling a hole, you obviously can’t do that.”

Who else says so?  How about Anna Schwartz, still on fire at 92.  The late Milton Friedman's collaborator on A Monetary History of the United Statespoints out out that as long as there's no transparency, the "recapitalization" won't add up to squat:

We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads — the difference between what it costs the government to borrow and what private-sector borrowers must pay — are at historic highs.

This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."

So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."

…Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Let them fail?  Schwartz, her illustrious accomplishments notwithstanding, just drummed herself out of the core of Very Serious People who get a hearing about how we got into this mess and how we get out.

Well, if we're this screwed, what can you do to protect yourself and actually turn this disaster to your advantage?  Let's turn it over to Addison for a special message, inviting you to a free Emergency Retirement Recovery "webinar" tomorrow:

Dear Agora Financial reader,

You know the story…

Bear Stearns gone…Lehman Brothers dead…Goldman and Merrill in serious trouble…AIG swindling billions in a government bailout…more massive bailouts that could amount to trillions, leaving the taxpayer – you! – on the hook…the gov’t plan to buy stakes in banks…

Bad stuff’s happening so fast that it’s tough to even keep up with the news of the latest destruction.

And, of course, it’s far more difficult to figure out just what you should do . How to rebuild your portfolio. Even how to prepare for you and your family’s future.

That’s why we’ve put together a FREE Emergency Retirement Recovery webinar for you.

It’s an action plan devised by one of our keenest – and most correct – analysts, Dan Amoss, CFA.

In the webinar, Dan calmly explains what you should do RIGHT NOW to weather this blistering storm, to survive its aftermath and come out stronger than ever before.

This free, easy to watch webinar will show you

· How we got in this mess in the first place

· Where we will go in the near-term future

· Specific ways you can protect yourself – and profit – from this dismal situation right now

This webinar will be released right at 11AM on Tuesday, October 21, 2008. If you choose to attend it, you will have exclusive access at that time. And you can immediately take advantage of the specific action plan right on Tuesday morning.

Just type your e-mail address in the sign up box on this webpage and you will receive immediate instructions on how to use your free emergency webinar.

Remember, there is no fee…no obligation…just information you can use right now to bolster your portfolio.


Addison Wiggin
Founder, Agora Financial

P.S. We’re feeling this downturn just like you are. That’s why we rushed to put together this free Retirement Recovery webinar . We wanted to give you immediate emergency solutions to shore up your portfolio and your future. So sign up now to take advantage of this urgent action plan…

Please note: This free webinar couldn’t be easier for you to take advantage of. You can use your existing Internet browser progam to watch it. You won’t need to install any new software or anything like that. You’re perfect with the very computer you use right now.

Also, there is no hidden agenda. When you sign up to see this exclusive event, we will not send you any e-mails that are unrelated to the webinar. You won’t be signed up for an e-letter or anything like that. We just feel this information is too important not to share.

The Daily Reckoning