by Calculated Risk on 3/03/2009 09:12:00 AM

James Baker writes in the Financial Times: How Washington can prevent ‘zombie banks’

[T]he US may be repeating Japan’s mistake by viewing our current banking crisis as one of liquidity and not solvency. Most proposals advanced thus far assume that, once confidence in financial markets is restored, banks will recover.

But if their assumption is wrong, we risk perpetuating US zombie banks and suffering a lost American decade.
...
First, we need to understand the scope of the problem. The Treasury department – working with the Federal Reserve – must swiftly analyse the solvency of big US banks. Treasury secretary Timothy Geithner’s proposed “stress tests” may work. Any analyses, however, should include worst-case scenarios. We can hope for the best but should be prepared for the worst.

Next, we should divide the banks into three groups: the healthy, the hopeless and the needy. Leave the healthy alone and quickly close the hopeless. The needy should be reorganised and recapitalised, preferably through private investment or debt-to-equity swaps but, if necessary, through public funds. It is time for triage.

There are calls across the political spectrum to avoid zombie banks. No one wants to nationalize the banks, just preprivatize the "hopeless".

This is similar to my suggestion (and others) a few weeks ago:

The banks will probably fall into one of three categories:

1) No additional assistance required. ...

2) The banks in between that will need additional capital. This is where the Capital Assistance Program comes in: ...

3) Banks that will need to be nationalized or sold.
...
The sooner the better, although March 12th works for me (30 days from Geithner's speech)! ...

BTW the banks have been told to submit their stress test results to the Treasury by Wednesday March 11th. Although the stress test appears inadequate, and the 3rd option - "closing the hopeless" - is apparently off the table.