Financial system must tap the taxpayer

Yves Smith is very concerned about the idea that the "Financial system must tap the taxpayer".

Krishna Guha in the Financial Times argues that US banks need new equity ASAP to prevent the operation of a "financial accelerator," which is basically, just as leverage feeds on itself, so to does deleveraging: falls in prices lead to margin calls, which lead to forced selling, which lead to more margin calls. We now have the institutional version of that phenomenon, which is that asset price falls lead to mark to market losses, which for banks holding similar assets on their balance sheets, generates an equal markdown of equity, which leads to deleveraging, further depressing asset prices.

Guha argues that private sources probably won't step forward to provide the needed equity; therefore the government must, otherwise it will resort to monetary stimulus, which given the already worrisome uptick in inflation, isn't such a hot idea.

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Smith would rather guarantee the customers through FIDC, but is against the bail-outs because of the moral hazard. Smith concludes:

Conversely, as Gillian Tett has argued (and I think she is correct here) there is money sitting on the sidelines that would come in and make investments, including recapitalizing banks, once investors had confidence that the bottom had been reached. Thus flushing out the losses is a vital to returning to some semblance of normalcy.

John Dizard has suggested the use of regulatory forbearance, which is code for letting the firms operate in some sanctioned manner with less than the normally required levels of equity (presumably with much closer oversight).

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Smith misses the point that the State exists to protect the interests of the ruling class. At this point in time, the ruling class is in real danger of losing its capital. Therefore, the State must act to safe-guard that capital by absorbing the losses through some sort of compensation.

The moral hazard only applies to those who are not in the ruling class. The longer we tolerate this sort of behaviour by the ruling class, the more we will get screwed.