The Federal Reserve’s announcement of an open-ended bail-out for Wall Street’s endangered financial firms and banks opens an ominous new chapter in what might be called “market socialism with American characteristics.” If Washington tries to do something for “losers” who are ordinary citizens, financial titans complain about violating free-market principles. When the titans themselves are going down, they rush to their patrons at the central bank and demand extraordinary relief. Government must save the big money, we are told, for the overall good of the economy. Thus, the financial system’s reckless losses–approaching $1 trillion but probably far more–are being “socialized,” dumped on the public, the very people victimized by its snares and falsified valuations.

Put aside the obvious hypocrisy and greed. This nation is on the brink of a historic catastrophe. It requires emergency responses from the federal government on a scale not seen since the Great Depression and the New Deal, the subject of this special issue. Yet the rescue party is composed of the same people who co-wrote this disaster. They are, first, the financiers who indulged their own appetites for extreme wealth and enlarged a financial system of esoteric fakery that inflated prices and profits. Second, the close collaborators were the Federal Reserve and other authorities who blessed this dangerous concoction and declined to enforce prudential standards.

Now the hoax is falling apart. Many millions of innocents, here and around the world, will suffer painful consequences. The authorities, meanwhile, are trying to “save the system” by propping up failure. We do not suggest that the government should not intervene. On the contrary, it must intervene far more forcefully–using the unique emergency powers of the Federal Reserve and Congress to cauterize the wound and take over private firms if necessary. To impose stern new rules of conduct on financial firms as the price of rescue. To ensure a reliable flow of capital and credit to the real economy–industry, commerce and consumers–which has been bullied for many years by Wall Street’s distorted values.

In a nutshell, here’s what the Fed did after tortured negotiations with Wall Street players: it first bailed out Bear Stearns with a loan that failed to reverse the collapse of the firm’s stock price and assets. Then it gave JPMorgan Chase a loan guarantee of $30 billion to protect it against losses as it took over Bear Stearns. Most significant, the Fed promised open-ended loans on easy terms to some twenty other major investment houses to protect them against the same threat. Nobody can put a price tag on all of the central bank’s rescue promises–many hundreds of billions if the deterioration continues–but the main point is, the Fed has agreed to take the rotten financial paper, such as home mortgage securities, off the hands of these troubled firms.

What did the Fed demand in return? Not much, it seems, but nobody knows. These private deals were made among gentlemen of high finance; no need to bother the public with complicated details. If that sounds harsh, check out the websites of the Federal Reserve Board and the New York Federal Reserve Bank. Their brief, utterly opaque announcements were addressed to bankers, without a word of explanation for citizens. In this crisis, the Federal Reserve is an untrustworthy agent for the public interest. Its institutional bias is to defend the club members and cover up its own errors.

To understand the gravity of our larger situation, think of this crisis in three layers. The first layer is the panic–the visible worldwide flight of investors and other banking interests from the poisoned assets in the US system. The second layer is the deflation of Wall Street’s long-running hyperinflation of financial assets, the value of stocks, bonds, short-term loan paper and other instruments. For two decades, the Fed tilted monetary policy to favor capital over the real economy of production, creating dangerously lopsided conditions. Now Wall Street is going through its own contraction, and many more high-flying firms, including hedge funds, will fail or be taken over at bargain prices or both. In the long run this should be good for the US economy, restoring balance that the Fed’s one-sided monetary policy destroyed. But in the short run it could be perilous–starving the productive economy of credit.

The third layer of crisis is the massive loss of US capital. That means more debt will be piled on the nation’s already massive indebtedness to foreign creditors. One way or another, the country cannot restore itself unless it replenishes lost capital–not simply for banking and finance but for the overall economy. To put it bluntly, this means a bailout from abroad–the Asian and Arab nations with vast surpluses of capital. Those nations (one hopes) will buy larger shares of US companies, including Wall Street, or lend directly to the US government or both.

An activist government would respond aggressively on many fronts, but unfortunately we don’t have one. Congress, including most Democrats, has been utterly deferential to the Fed and the financial titans. The President is clueless, though he may still veto any positive legislation. But this crisis won’t wait for the next election. Here are some steps that Congress ought to try now:

§ Force the Federal Reserve to come clean about the secret terms of any deals it made with the bankers. What operating rules did the Fed impose on the firms it assisted? What is the real public exposure to loss? These bailouts should strip failing firms and shareholders of their entire assets, including contracts that allow CEOs to ruin their firms and then walk away with $100 million in severance pay.

§ The central bank needs a public agenda for bailing out Wall Street–a set of new requirements on future behavior in investment and banking that begins to reform the financial system. If a troubled bank refuses to accept these terms, let it fail. If necessary, put the firm in receivership and take it over.

§ Create a US recovery fund to invest in restoring the real economy, not the shrinking financial system. It would borrow capital to support an aggressive agenda of public investments. This fund could take over the ruined securities now held by the Fed and manage them for some years until they can be gradually put back into the marketplace without slaughtering homeowners or depressing real estate prices. Any firm bailed out by government must be prohibited from ever buying back these assets on the cheap, profiting on its own failure as Wall Street firms did in the savings-and-loan crisis.

§ Americans need to increase their savings safely. Congress can create a federal savings fund that pays modest interest rates and protects savings against inflation and the shenanigans of private funds. This savings pool, guaranteed by government, can lend capital to the recovery efforts and even become a first step toward repairing the broken pension system.

In other words, it is time again to think big, the way New Dealers did. But even reform-minded legislators are intimidated by the power of Wall Street money and ideas. The crisis might change that, as politicians begin to realize that Wall Street is yesterday.