The US authorities have tried just about everything else. They've cut interest rates, they've flooded the system with liquidity, they've engineered rescue takeovers, they've nationalised Fannie Mae, Freddie Mac and AIG, yet still the storm kept building, threatening the very foundation stones of the financial markets and the American economy.
Now, the big cannon is about to be deployed – the last line of defence. Finally we've reached the point arrived at on at least three occasions before this century when the storm has become so bad that the American taxpayer is being forced to nationalise the bad debts of the country's major banks. By so doing, the Federal authorities hope to unfreeze the system, restore confidence and get the banks lending again so thateconomic growth can resume.
What was announced yesterday by Hank Paulson, the US Treasury Secretary, was a bold step, but it is not unprecedented. Many commentators have been saying for months that such action had to be part of the solution.
The idea is that banks are able to swap their most problematic mortgage loans for Treasury bills. With the bad debts thus removed, the banks are restored to health, confidence returns, the atmosphere of febrile mistrust between counterparties is removed, the funding machine begins operating afresh, and banks start lending once more, thereby reinvigorating poleaxed economic activity. That's the theory, anyway. Will it work?
The euphoric reaction of markets yesterday suggests that possibly it will, though in some respects this looks as irrational as some of this week's falls. At the very least, there is a long and difficult workout ahead, with much of the economic pain still to come. Yet this kind of action has worked before, most recently with the Savings and Loans crisis in the early 1990s, when hundreds of billions of dollars worth of bad debts were taken on by the state-sponsored Resolution Trust.
Before that, there were "Brady Bonds", the Treasury securities issued in the 1980s to banks to bail them out of their Latin American debts. Then there was the great big grand-daddy of all state bail-out funds, the Reconstruction Finance Corporation, which took on bad debts in the 1930s which in terms of today's money would be valued at more than $1trillion.
There were no details yesterday of what's proposed, but maybe it will require something similar this time around. The most that Mr Paulson would say was that hundreds of billions of taxpayers' money would have to be provided.
He didn't like it, but, in his view, the cost to American families of bailing out Wall Street was far less than the alternative of frozen credit markets unable to finance economic activity. All consideration of moral hazard – that investors must be made to pay for their excesses or they will merely be even more reckless in the future – has gone out the door.
Cynics will say that it wasn't until the mighty Goldman Sachs, Mr Paulson's former employer, was threatened by the financial maelstrom that the Treasury acted. It's a cheap shot, but, in the circumstances, not so surprising. American citizens are going to spend years paying for this clean- up through higher taxes.
For nearly a century now, American capitalism has been dealing with the repeated crises it seems to be prone to through massive state- funded bail-outs of the sort now proposed. It's hard not to admire the survivalist instincts which instruct these awesome policy responses. What's more, every time it happens, America reboots, the regulatory system is re-engineered, and eventually the economy emerges reinvigorated and more powerful than ever.
Yes it is expensive, but, in the scale of meeting the costs of human folly, it's not that bad. Wars are much worse. Big ones have a tendency to impoverish nations for generations. And if all goes according to plan, the taxpayer may even get his money back as the bad loans are slowly worked out through the system in an orderly way.
Do we need something like it here in Britain? It may yet come to that.Reuse content