Banking system problems

The following quote from Bridgewater Associates succinctly puts the current problems that we are having in focus.

"The root problem is that debts that were incurred to finance assets at high price levels remain in place at their original amounts even though the assets that they financed are now worth far less. Debt that was incurred to finance extrapolated high incomes remains in place at its original amount even though incomes are now much lower. And, debts that were incurred to finance loans remain in place at their original values even though the loans that were made cannot be repaid. Until the debts are brought in line with the assets and the income, there is no moving forward no matter how much liquidity is provided or how eloquent the speech. And, until this happens, the self-reinforcing nature of the debt squeeze will only reduce incomes and asset values further.

"There is no easy way out of a debt restructuring. Someone will have to bear the cost of prior bad decisions. The people who should bear the cost are those who made the bad decisions to make the loans or those who financed the people who made the loans. They intended to profit and would have profited if they were right. But they were wrong, so they should lose. The government needs to allow the losers to lose and focus their actions on minimizing the knock-on effects of their failure on people who didn't do anything wrong (to minimize systemic risk). They should then take action to minimize the future exposure of the innocent to the future dumb decisions of the small minority, because no amount of regulation will ever eliminate dumb decisions, so you have to plan for them (through much lower bank leverage limits to cushion losses, bank size limits and non-bank entities playing bank-like roles to improve diversification, safety nets to prevent losers from poisoning the whole system, etc.)."

I really do like the part about there being no regulation possible that will eliminate dumb decisions. The government needs to be very careful to not overstep and cause more problems than the market has created already.

Banks shoring up their balance sheet with TARP 1,2,3,4 will continue to act in their own best interest which includes NOT LOANING money. Regulators are all over them, and they need to save their money as a hedge for future defaults. How to fix it, I do not know for sure, however as my first post alludes to and explains, the free money party went on for a long time and there is going to be a whale of a hangover for those that drank the most at the liquidity fountain of the FED's creating.