Capitalism without Capital

Can you have Capitalism without Capital?

That's the sixty-four thousand (er, trillion) dollar question occupying the financial markets right now.

At the moment, it's not clear whether there is a capital shortage, or, the capital that exists is simply frozen (and therefore not circulating). In truth, the two possibilities are not mutually exclusive ("Duh-uh," as Homer Simpson might say).

If capital is frozen, you thaw it by increasing confidence, which means issuing government guarantees, insurance, etc. That needs to be coupled with clear and complete corporate disclosure, so that depositors, debtors, creditors, etc. can tell the difference between financial institutions that are healthy and ones that are "zombie's" (the term for banks kept on life support by the Japanese government after that country's late '80's bust).

The second explanation, a capital shortage, is more problematic.

If there's too little capital, you need to replenish it. Exactly how to do that is the rub.

If you give more capital -- lots more -- to the entities that just lost theirs (actually, as it turns out . . . ours), you risk perpetuating the problems that caused the original mess (so-called "moral hazard").

However, if you simply let the chips fall where they may, you risk the sort of collateral damage we're now seeing (credit defaults, money market trauma, no inter-bank lending, etc.).

What comes next?

At a minimum, probably some sort of "financial amnesty" to encourage (compel?) key financial actors to produce balance sheets that the markets actually trust. From there, you start the process of "re-building from the ground up," as Paul Volcker just put it.