Luigi Zingales, Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago, recently authored an article advising the incoming Treasury Secretary of the fundamental problems in the financial system, why they have not been solved, what it will take to solve those problems, and why expectations of economic recovery need to be tempered.  Below is an excerpt that encapsulates the fundamental problems underlying the financial crisis:

Avoid wishful thinking on bank bailouts and kick starting the credit markets

Hoping that bankers who saw the writing on the wall might restart taking risks because they were offered a life line is wishful thinking. If the government really wanted to use the banking wreckages to restart the economy, it should have taken over these banks and directed the flow of credit, or should have poured an amount of capital so large that even scared bankers would consider restarting the lending process. Either way it would have been tantamount to a nationalization of the banking sector, with the problems this implies. And it would have required a massive amount of money. In October my rough estimate was $600 billion in equity just for the top ten banks.⁴ I am afraid I was too optimistic. Is there any limit in the subsidy taxpayers have to provide to bail out bankers?

Only in the absence of any feasible alternative to restart the lending process would this massive bailout be in the interest of the country. This is the way Secretary Paulson presented it to the nation. Ironically, however, he kept changing the solution that had no alternatives. Mr Geithner, please do not fall into this trap. We can save the banks as institutions and restart lending without a massive transfer of money from taxpayers to investors and bankers, and here is how.

The full article may be read at VOXeu.

[SOURCE: Yes We Can, Mr. Geithner, Luigi Zingales, January 19, 2009, VOXeu.org]