From reading the news you might believe that the financial crisis that we’re in is one of the banks. Banks might have caused some of the problems, but right now they need all the help they can get, even if that means chipping in tax payers money. Look again though. Since the beginning of this year, according to domain-b, the banking sector is down 32.5% since the beginning of the year. Sounds like a lot, but the S&P, one of the broader indexes went down by almost exactly the same percentage since the beginning of the year. To me that doesn't seem right. If this industry is on the brink and needs all help, shouldn't their investors be punished more? Apparently they think it is not so bad.
Or more likely, that whatever crisis comes, the banks will be bailed out, while other industries will not, so banking shares might actually be safer than others. According to the BBC Business Editor Robert Peston the world has now spend 5 trillion pounds on saving the banks. That's 7.8 trillion dollar. The same article on domain-b mentions that the total value of the banks went down from 8.3 trillion to 5.7 trillion. It also answers my question why if they need more money and belief in the free market they don't just increase the interest rates they pay on deposits. They don't need the money that much and can get it for free just by saying that if they'd blow up it would be Really Bad so hand over the cash.
So what do we do? We can't really call their bluff, can we? I think to some extent we can. The government should announce that from now on, no more money will be pumped into banks, no more interbank loans will be guaranteed, nor any bad assets being bought by the government. However, the government will buy all bank shares that drop to 17% of their current value. After a bank is nationalized and only then, will the government guarantee the loans etc.
Now step back and let the market do its work. Mass panic will be avoided since there clearly isn't any systemic risk; the government still guarantees the risks, just only after nationalization. So the market will get to focus on which banks it think will make it and drive the share prices of the ones it think won't make it down, with the 17% a floor. Most likely a lot of banks will never hit the 17% and will just be bought out by others. The total cost of this bailout has ceiling (the guaranteeing of loans less so, but at least it will be the states loans that are guaranteed) and the invisible hand can finally hit the guys that caused this.