The bailout of Wall Street banks began a while ago, when the Federal Reserve and the Treasury doled out easy loans. But on March 16 the scope of the rescue widened dramatically, with the Fed absorbing the losses at Bear Stearns, backing its sale at a heavily discounted price to JPMorgan Chase and announcing its willingness to make further loans to the rest of the Street against worthless collateral. The banks are being saved partly because they have friends in the right places but also because the failure of even one investment bank would undermine the others and spread havoc in the real economy.

In contemplating what should be done, consider an earlier episode in the unfolding crisis. Between November 2007 and January 2008 several stricken banks--Citigroup and Merrill Lynch being the largest--were recapitalized by infusions of some $70 billion from a string of foreign "sovereign wealth funds." Countries like Norway, Australia, China, Singapore and Dubai have been building up "future funds"--pools of social wealth that give the state room for maneuver and can be devoted to a variety of uses--in part by acquiring preferred stock in the troubled US banks in return for their cash investments.

Elementary justice requires that the big investment banks pay a price for Washington's bailout, which could well top $100 billion. The Federal Reserve or Treasury, like the sovereign wealth funds, should receive preferred stock in the banks proportionate to the help they receive. The stock would not be sold but rather transferred to a regional network of autonomous social funds, which would benefit from future dividends on the stock. It could be handed, for instance, to the network of state-level Social Security and Medicare trust funds.

The deregulators and banks brought on the crisis through their irresponsible behavior. The 1999 repeal of the Glass-Steagall Act--which separated investment banking from commercial banking--destroyed a defense against speculation. In 2004-05, researching a book about "how finance is failing us," I was shocked to discover that swanky Wall Street concerns had bought up a string of loan sharks--subprime lenders, some of whom had been convicted in court of predatory lending. The banks preferred bad assets to good, as they could be bought cheap and then repackaged as fancy financial products with triple A ratings. The alchemy of financial legerdemain could supposedly turn dross into gold but could do nothing for precious metal itself.

New legislation should ban investment banks from personal finance and encourage them to get back to financing domestic investment in manufacturing and infrastructure. A good model would be Norway, hit by a banking crisis in 1988-92. The government took over the failing banks, expropriating the owners, and restored them to viability. It then used the proceeds and oil revenues to set up a pension fund, now worth roughly $390 billion. This fund is invested in accordance with a published set of criteria, embracing diversification, prudence and ethics.

In World War II the US government pumped huge resources into war production and in return took equity, held by the Reconstruction Finance Corporation. After the war these holdings were simply sold. After the savings-and-loan debacle the Resolution Trust Corporation was set up in 1989 to bail out bankrupt S&Ls, which it then sold off--with the proceeds disappearing into the budget deficit. These are highly flawed models. The RTC bailouts subsidized the banking sector in an opaque way and without needed re-regulation (as Joseph Stiglitz and Bruce Greenwald point out in Towards a New Paradigm in Monetary Economics).

In the twenty-first century, social funds should be built up, not run down, and they should be obliged to operate in a transparent and accountable way. Future funds can help finance badly needed programs while also furnishing a democratic lever over big business. The credit crunch and recession will bring many problems--but something will have been gained if this opportunity to reinvent progressive economic policy is recognized and acted upon.

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