Amid the turmoil of the 2008 financial crisis a myriad of events unfolded that the general public knew nothing about, writes New York Times reporter Andrew Ross Sorkin in a new book titled "Too Big to Fail."

Wall Street fell from the dizzying heights of good fortune to calamity in a matter of months. To a large degree it's still to early to tell whether financiers and politicians involved made the right choices.

"At its core 'Too Big to Fail' is a chronicle of failure -- a failure that brought the world to its knees and raised questions about the very nature of capitalism," writes Sorkin in his behind-the-scenes account.

He spoke with Reuters before giving a lecture at the London School of Economics on Thursday.

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

There is so much talk of a new regulatory framework for the financial sector, anyone would think it was an important issue.

Unfortunately, it is almost irrelevant, for the simple reason that, however sophisticated the new regime, experience shows it will be bypassed and/or captured by banks of one kind or another, possibly by novel types of institution invented specially for the purpose.

This is true even in the unlikely event that the whole world – with the possible exception of North Korea – embraces the new regulations and enforces them with vigour.

The only type of intervention which has a hope in hell of success is one based on size. As Mervyn King has said, when a bank is TBTF (Too Big To Fail), it is just too big.

What is needed is breakup along functional (and, where necessary, geographic) lines, separating the boring but essential utility business of deposit-taking and payment-transfer from the exciting risk-taking of investment banking. A once-and-for-all breakup would have to be followed by continual monitoring, to ensure that takeovers and mergers did not breach the size limit and take us back to the TBTF dilemma.

The aim should be straightforward. If banks were cut down to manageable size, the taxpayer’s liability could be limited to deposit insurance alone. Banks could be allowed to fail in the same way as firms in other industries and would no longer be able to hold Governments or central banks to ransom, as they have repeatedly done in the last twenty or thirty years.

Moreover, break-ups would bring other benefits. Without an implicit taxpayer guarantee, there would be more incentive for institutional shareholders to insist on responsible management behaviour and to impose remuneration packages consistent with it. This mechanism of shareholder vigilance, which failed totally in the run-up to the current crisis, in my view offers the best hope for the long term. By their shameful passivity, institutional shareholders must carry a major share of the responsibility for the existing mess, and everything should be done to shame them into activism in future.

Will breaking up the banks eliminate systemic risk altogether? Of course not. But it will mean that the world economy will no longer be hostage to the irresponsible behaviour of a handful of bankers consciously pushing the banking system to the limit, or, as has recently been confirmed in accounts of the demise of Lehman Brothers, indulging in brinkmanship with the authorities.

The difficulty is how to get from here to there. As I said in an earlier blog, we need governments too big to be captured, and it is now plain that they exist neither in Washington nor in London. Predictably, the UK Government has shown no stomach whatever for the fight, even though it effectively owns two of the country‘s largest banks. It is a catastrophic error – one is reminded of the first Gulf War, when, with Saddam Hussein at their mercy, the Allies fell back on technicalities to justify leaving him in power.

It would be ridiculous to compare the evil of tyranny with the excesses of bankers, but in pure monetary terms the current crisis has already cost several times as much as the two Gulf Wars added together. Yet not only are Western Governments running away from confronting the banks, they appear determined to take on almost anyone else involved in finance. In particular, the EU’s hostility to so-called Alternative Investments (hedge funds and private equity) is, if anything, likely to make institutional investors as a whole even more reluctant to intervene than they were before.

As ever, it seems there is no situation so bad that our endlessly creative politicians cannot make it worse.

Investors have more than one reason to celebrate two new accounting rules. Besides forcing banks to fess up to the risks they are carrying on their books, new standards for off-balance sheet assets will make it harder for companies to inflate earnings artificially.

The new rules - FAS 166 and 167 - are desperately needed to prevent banks from hiding assets to increase leverage. Lending that isn't supported by capital is a main ingredient behind unsustainable credit bubbles, and banks' off-balance sheet games played a big role in the most recent one.

But another reason banks like off-balance sheet structures is that it enables them to manufacture profits.

Coming up to the end of a quarter, if a company is a bit short of its earnings target, it can package some assets together into a security and "sell" them to an off-balance sheet entity.

The entity is conjured out of thin air with a small equity investment by the company itself. The entity "buys" the securitized assets at a nice markup, enabling the company to book a profit on the sale.

Is it really a sale if the company still owns the risk? Of course not. If I sell an asset to you, a share of stock for instance, then I transfer all the rights of ownership. Any gains or losses in the stock are yours alone.

With many off-balance sheet entities, however, companies aren't really transferring risk to anyone else. They're just pretending to do so in order to lever up and recognize a gain.

It's the acknowledgment of risks that is most important. Pushing assets off balance sheet -- into the "shadow banking system" -- put them beyond the reach of regulators, whose job it is to make sure banks have enough capital to absorb losses.

For their part, banks like to fly as close to the sun as possible, operating with as thin a capital cushion as regulators will allow. This is the essence of leverage. The more assets a firm controls relative to the equity on its balance sheet, the higher its potential returns on equity.

If you put down 20 percent to buy a house, and the house's value appreciates 10 percent, then the return on your equity is a tidy 50 percent. But if you put down 5 percent, that same 10 percent increase in price is a 200 percent return.

The trouble with this strategy is that it works in only one direction. If asset prices fall, banks with smaller equity cushions go horizontal rather quickly.

At the height of the bubble, big banks were operating with equity cushions in the range of 2 to 3 percent. And that was before accounting for off-balance sheet assets.

Since then, banks have raised more capital, putting them in the range of 4 to 5 percent, but bringing assets back on balance sheet will have a meaningful impact. Citigroup will be adding $159 billion of assets, Bank of America $150 billion, JP Morgan Chase $130 billion and Wells Fargo $109 billion.

Goldman Sachs and Morgan Stanley haven't yet disclosed how much they will be bringing back on, according to their most recent quarterly filings with the SEC.

Unfortunately, and contrary to recent comments about the importance of raising capital from President Barack Obama and Treasury Secretary Timothy Geithner, regulators are considering giving banks a year to phase in these assets for regulatory capital purposes.

This seems foolish. With equity markets nice and bubbly again, it's not very difficult for banks to sell stock. If regulators make clear that additional capital will be required soon, banks may act pre-emptively to raise it now.

The system will certainly be stronger if they do.

President Barack Obama pledged on Monday "to put an end to the idea that some firms are 'too big to fail.'"  Though he outlined some worthy prescriptions, he failed to face up to the very size and power of the financial institutions that makes "too big to fail" possible.

For the big have gotten even bigger since the start of the financial crisis. At the end of 2007, the Big Four banks -- Citigroup, JPMorgan Chase, Bank of America and Wells Fargo -- held 32 percent of all deposits in FDIC-insured institutions. As of June 30th, it was 39 percent.

(If the image doesn't load, click here.)

In total, they had $3.8 trillion worth of deposits as of June 30th. Compare that figure to the FDIC's Deposit Insurance Fund, which showed a balance of just $10.4 billion on the same date.

The FDIC has been the most effective regulator since the onset of the crisis, closing down failed banks in order to limit risk to taxpayers. But its resources are woefully inadequate to deal with the largest institutions. (I am excluding the $500 billion credit line it has at Treasury; those are taxpayers' resources, not FDIC's.)

And that's just the commercial banking side. These banks -- especially Citigroup, Chase and Bank of America -- have huge investment banking operations that are maddeningly complex and, systemically-speaking, very dangerous.

Obama certainly recognizes the problem -- "the system as a whole isn't safe until it is safe from the failure of any individual institution."

But his recommendations -- more stringent capital requirements, stronger rules and a "resolution authority" to cope with systemic meltdowns -- won't solve it once and for all.

To be sure, higher capital requirements are a very good start. They not only give banks a bigger cushion to deal with losses, they also limit the amount of credit they can flush through the system. This is a good thing: Too much credit is the air that inflates dangerous asset bubbles in the first place.

But higher capital requirements won't make too-big-to-fail banks much smaller. At best they will penalize the biggest banks by reducing their returns on equity, giving smaller banks a leg up competitively.

A tax on assets is another good idea to discourage growth, but what we need is more aggressive action to force shrinkage.

For instance, resurrecting a version of Glass-Steagall would be highly sensible. Commercial banks have no business using their federally-insured balance sheets to finance risky investment banking operations. The two functions should be split.

And what ever happened to anti-trust laws? Among them, Citigroup, Chase and Bank of America control two-thirds of the credit card market. That stranglehold gives them significant leverage vis-à-vis consumers.

Another issue is derivatives, which Obama didn't really address.

Notional exposure still totals tens of trillions at the biggest banks. Sure, many of these positions offset one another, but that assumes the daisy chain won't break. To insure market integrity, the biggest players in it all have to get an explicit "there will be no more Lehmans" guarantee.

This gets to the heart of the issue. Though Obama says a return to "normalcy" means emergency rescue facilities can end, it's a safe bet that they'll come right back the next time we have a systemic event.

The only way to ensure we'll never need them again is to eliminate too-big-to-fail banks. The fastest way to achieve that is to break them up.

A year after the government's seizure of Fannie Mae, Freddie Mac and AIG , not to mention the bankruptcy of Lehman Brothers that sent the global financial system into a tailspin, very little has changed to prevent debt from being sliced and diced, again and again.

This is a mistake. Although there were many factors contributing to the downfall of the global financial system, the repackaging of toxic debt into esoteric financial products was at the heart of the credit crisis when it erupted in 2007.

It's easy to forget, particularly when many are focused on anniversary tick-tock accounts of the last days of Lehman Brothers, how nasty CDOs -- or worse, CDO squareds -- became so incredibly popular in the first place.

Yet, after all the damage, the trillions of dollars lost and the biggest state intervention in financial markets since the Depression, there has been no movement to ban their creation.

Securitization in its broadest form -- taking underlying collateral, bundling it together and selling it as tradable debt -- is still hailed as an important 20th-century invention that has helped worthy borrowers get the credit they need to buy a home, car, or education that would otherwise be out of their reach.

Policymakers, understandably, are anxious to get it started again after the market snapped shut last year. Wall Street, and investors taking advantage of generous financing from the Federal Reserve, are happy enough to oblige.

And it has worked. As of last week, new bonds backed by consumer debt reached $100.5 billion for the year, according to Barclays Capital. While a fraction of the pre-crisis market, that deal volume represents a healthy revival of a near-dead business. Three-quarters of the new deals are eligible for Fed financing.

The problem is phase II -- when these securities are then repackaged into something else. At the margins, it's already under way. Banks are repackaging problematic bonds backed by residential mortgages and the current disaster zone, commercial real estate loans, so they can slice off a new piece that can be resold with better protection.

The amounts are still small, but it's a reminder of the temptation to shift around a problem asset so investors can feel better about risk.

Although securitization has been around for more than 30 years, the housing and credit boom combined with the computing power of the 21st century gave rise to the proliferation of these repackaged goods filled with bad home loans.

Home loans, though, were just the most bountiful fodder to be found. The next go-around could involve using, say, bonds backed by life insurance policies -- the resurfacing fad among Wall Street banks -- as the building blocks for a new product.

In the name of simplicity and transparency, the repackaging of securities should just be banned, as I've argued before. This will ensure that junky debt doesn't get cut into so many pieces that understaffed regulators, rating agencies, investors and bank executives lose track of just who is left holding the bag should things head south.

Much of the public outcry and regulatory fervor has been focused on the banks and their reluctance to give up big bonuses for a job well done, or done badly as the case may be.

This is understandable, given the hardship banks and their creations have caused, but this won't necessarily prevent creative innovation from running amok.

Keeping banks from creating new products out of old ones will go a long way to make sure we're not right back where we started when the next crisis unfolds.

The Year Since Lehman -- related columns:

A year after Lehman, the good news

Banking? Keep it simple, stupid

A year on, it's still a housing story

– Wei Gu is a Reuters columnist. The opinions expressed are her own —

Chinese banks are like enthusiastic runners on an accelerating treadmill. The weakening economy means poor lending decisions are threatening to catch up with them, but the banks are sprinting ahead by expanding their loan books ever faster. They cannot keep this up for ever.

For now things still look fine. China Banking Regulatory Commission (CBRC) this week claimed that Chinese banks were managing credit risk sagely, pointing to record low non-performing loan ratios. Given the massive increase in the number of loans outstanding — up 24 percent since the start of the year — it’s not surprising that the proportion of them that are non-performing at large commercial banks, which accounts for 60 percent of the lending, has declined from 2.4 percent to 1.8 percent in the past six months.

Chinese banks appear to be focusing their lending on regions which have suffered the most in the crisis. The five regions that have shown the largest increase in new loans are the ones that were hit hardest by the downturn, namely coastal cities such as Guangdong, Jiangsu, Zhejiang, and Shandong, plus Beijing. These are also the regions that have experienced among the slowest growth this year. This suggests that loan growth is being driven by official policy rather than the product of bankers seeking the most attractive investment opportunities.

Chinese banks had double-digit NPL ratios before Beijing cleaned them up in preparation for their listing on foreign exchanges. Foreign banks with risk management expertise were brought in, and offered cheap stakes in Chinese institutions to encourage them to share their knowledge. This led to an improvement in lending standards as Chinese banks installed expensive computer databases and formed central credit offices.

It is not clear however how deeply these reforms have been entrenched. The banks remain very decentralized and lending standards are generally lower than their foreign counterparts.

In the past few years, Chinese bankers were restrained by the regulator from going on lending sprees. Banks were given lending quotas to prevent the economy from overheating. This year, with growth the main concern, there were no ceilings.

Chinese banks have clearly now opened the flood gates and are taking on more credit risk. The chief banking regulator Liu Mingkang said at a closed-door meeting in Tianjiin this April that the maximum Chinese banks should lend out a year is 6 trillion yuan ($878 billion), anything above that would be deemed as risky. During the first half alone, they lent out a whopping 7.37 trillion yuan ($1.08 trillion).

The current NPL statistics are irrelevant. The test for Chinese banks will come in the next 2 to 5 years, as the latest wave of lending shows its worth. True, many infrastructure loans seem to have implicit government backing, but less come with strong underlying cashflows. Instead of celebrating the record-low NPLs, the regulator should take it as a worrying sign that Chinese banks are now running hard to stand still.

— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund —

Earlier today I wrote that Sheila Bair is one of the few financial regulators who gets it. And by getting it, I mean not sucking up to the banks and the big money interests on Wall Street. You know, the guys (and most of them are guys), who got us into this financial mess. Tim Geithner, on the other hand, is a regulator who just doesn't get it.

It's not that the Treasury secretary isn't smart--he is. And it's not that he's not up to job--he is. It's that Geithner is too much of a politician and his views have been molded by people who work on Wall Street.

So, that's why we have Geithner telling The Wall Street Journal today that Wall Street isn't reverting back to its old ways--even though everything indicates that's exactly what is going on. In Geithner's world, things are getting better and the banks are becoming better citizens:

I don't think the financial system is reverting to past practice, and we won't let that happen. The big banks are running with much less leverage now, much more conservative liquidity cushions. There has been a significant shrinking of their balance sheets, getting rid of bad assets and cleaning up. And the weakest parts of the system don't exist anymore.

But Geithner lives in the land of Oz. A land where we should ignore the man behind the screen and all the toxic assets that still line the balance sheets of the nation's banks.

The trouble is the rest of us live in the real world where the roads aren't paved with gold bricks.

– James Saft is a Reuters columnist. The opinions expressed are his own –

Rising pay in the finance sector in the wake of the global financial crisis is no surprise and is driven partly by the government’s bailout itself and the underwriting of banks that are too big to fail.

News that some financial firms benefitting from government largesse actually increased the share of revenue they pay their employees sparked a lot of outrage but more heat than light.

The good news is this new bulge in pay may not be sustainable.

The bad news is it will probably only be stopped by further regulation, regulation which may never come.

To understand what is going on you need to understand the economic concept of “rents”, essentially the extra money a given individual or industry is able to extract from its clients above what it would be able to if there was perfect competition.

A monopoly will charge a very high price for goods or services because, well, they can. Needless to say economic rents are not a good thing, unless of course you are in receipt of them.

Workers in financial services have been huge beneficiaries of economic rents in recent years. They sell products which are complex and poorly understood by clients. They have been very lightly regulated, and it has been hard in many areas for start ups to compete with large firms and drive down prices.

A study by economists Thomas Philippon of New York University and Ariell Reshef of the University of Virginia found that about 30-50 percent of the extra pay bankers get as compared to similar professionals is attributable to rents. <http://people.virginia.edu/~ar7kf/papers/pr_rev15_submitted.pdf>

In other words, banking is able to overcharge its customers and bankers are able to capture a huge portion of that for themselves. Why? Because they don’t face enough competition, their products are too complex for clients to be able to understand and bargain effectively, and crucially because regulation allows for this state of affairs.

Rising complexity, in my view, has probably been fuelled at least in part because it drives margins and tilts power away from bank clients and shareholders and to employees.

“The more complicated the product the easier it is for people to hide the risks,” Reshef said in an interview.

The study shows that excess pay in banking is very closely linked to lax regulation, as opposed to higher productivity or early adoption of technology.

Relative compensation in finance in the early part of the last century peaked not in 1929 before the crash but several years later just before the more stringent regulations kicked in. Relative compensation began to climb again in the 1980s as deregulation happened and rose like a rocket since 1990.

WHAT JUST HAPPENED??

The economic crisis, far from undermining circumstances that allow for rents and excess pay, has in some ways cemented them.

One area of complexity, asset backed finance, has been eviscerated but many others still sail on relatively unaffected.

Most importantly, the doctrine of too big to fail has confirmed and reinforced the superior market position of those banks and investment banks which still survive.

The U.S. has essentially made it known that the current players will not be allowed to fail. These banks had an advantage already based on their size, that advantage is now greater and carries an implied government guarantee.

Ladies and gentleman, this is your banking recapitalization program: an unfair playing field. I might be able to swallow that as the economy needs a banking system. But, if you believe Reshef and Philippon’s data, a goodly part of the essentially unearned money that should be going to recapitalize the banks is ending up instead overpaying the bankers.

It is true that part of the reason banks are paying their best people so much is that a tectonic shift in banking will place a higher premia on the most talented. Fair enough, but only if we see a shrinking pool of compensation money being tilted towards a smaller elite.

The rise and rise of the rents extracted by bankers from the economy will only really be stopped by government intervention, since, given we have a system of bank insurance, it only really can exist with government connivance.

You could make good progress controlling excess compensation and banking rents by placing limits on size, by taxing complexity (which after all hasn’t really served us well), and by limiting the use of leverage within the parts of the system that can make a call on the taxpayer.

If you look at the Great Depression, this process will take about four years. We’ve not made a very encouraging start.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

- Brendan Wood is Chairman of Brendan Wood International, a global intelligence advisory firm. Recently, BWI published the World’s TopGun CEOs as ranked by 2500 institutional investors, which provides insight into the executives in whom shareholders feel the greatest confidence. The opinions expressed are his own. -

Brendan Wood International tracks the competitive position of investment bankers in global and regional markets. It also compiles the confidence rankings of hundreds of global shareholders in corporate investments, including those in the world’s leading banks. As of mid-2009, the Brendan Wood Investor Panel found a mixture of sharp criticism, but also some occasional strong praise for these “newly refurbished” financial behemoths.

First, the bad news: while all the banks have by now somewhat improved their situation from what it was earlier in the year – repaying $68 billion in government assistance, raising new equity, and carrying out a number of boardroom shuffles – their improving news and modest profit reports have not led to any total absolution from the Brendan Wood Panel for the worst falls from grace when the credit crisis exploded.

Citigroup still draws some harsh judgements, and not just for the hangover consequences of the Sandy Weill and Chuck Prince eras, but for its more recent direction by present CEO, Vikram Pandit.

Responses from the Brendan Wood Panel were taken before Pandit’s recent new top management shuffle (Edward “Ned” Kelly previous CFO is now Strategy and M&A leader becoming Vice-Chairman, John Gerspach, previous controller and Chief Accounting Officer is now CFO, and ex Merrill Lynch Vice Chairman Eugene McQuade is now CEO of Citibank NA, not to mention the stepping down of Chairman and CEO Bill Rhodes), but it appeared unlikely that any such changes would be greeted with great enthusiasm from shareholders.

The unhappiness of Bank of America shareholders with the costs and immediate consequences of the Merrill acquisition are now a matter of public record. It showed up in the shareholder commentary from the Brendan Wood Panel, but there was also recognition that the Bank actually did very well on investment banking performance rankings, leaping up to the same kind of level as JP Morgan Chase in the second quarter.

Again in the case of Citigroup, some shareholders expressed discontent that went beyond the specific issue of the expensive Merrill acquisition, fearing ‘a disharmonious culture’. But there was also recognition from shareholders that the large Merrill distribution network can still be a gradual source of increasing strength.

Much more positive assessments were offered for JP Morgan Chase, and of the specific contributions made by Jamie Dimon. He was cited for ‘doing a pretty good job of keeping a balance’ between wholesale banking and the recently increased retail component, and of working with a good risk management team, finding areas to "counterbalance" those risks his bank has been taking.

HSBC and Wells Fargo were two other major banks with CEOs who won plaudits from shareholders. HSBC may be recalled by some as once having been one of the largest early bank acquirers of an American company loaded with subprime mortgage debt, an acquisition that the bank’s Chairman, Stephen Green, later admitted with disarming frankness was one they wish they never had made. Nonetheless, they came through the whole crisis with much less visible damage than other global banks, and the Brendan Wood Panel’s comments included one that CEO Michel Geoghegan was "one of the best CEOs out there," who has "guided the bank through the crisis much more effectively than his peers, and has a wealth of experience."

John Stumpf of Wells Fargo drew similar enthusiasm, for "consistency and principles," and for skill in executing deals: ‘He is one of the best in the business of the cross-sell.’ Wells Fargo also drew remarks that ‘management had considerable influence on who sat on its board, but that this was no bad thing’, thus making the board an active participant rather than a passive and uninvolved group.

Goldman Sachs, unsurprisingly, also continued to receive some strong recommendations from the Brendan Wood Investor Panel, especially for "strong risk management skills."

There were not too many kind words from shareholders about other commercial and investment banks. But there also appeared to be, for the most part, a stoic acceptance of their existing structures, with some likely new regulatory controls coming in any case. It was noted that British banking regulation required much greater board independence than found in American practice, but that this had not made any apparent difference in the impact of the credit crunch on either side of the Atlantic.

Overall, shareholders can scarcely be regarded as taking entirely "public interest" views on the great risks into which most banks entered over the last decade. After all, many enjoyed a rather long run of 20 percent annual returns, and it appears that many of the losses now coming home to roost will be at least partially laid off on taxpayers.

However, the comments from the Brendan Wood Investor Panel are a useful realistic source about investment perception, and of general attitudes in the business community. Shareholders have been chastened by their recent experience, but not entirely persuaded that government has found the right answers to restoring a healthy and well-capitalized financial sector.

-- Margaret Doyle and Paul Taylor are Reuters columnists. The opinions expressed are their own --

LONDON/PARIS, April 23 (Reuters) - Germany is to set up a system of bad banks before the summer recess to hold some 250 billion euros of toxic assets. Finance Minister Peer Steinbruek has assured taxpayers that his solution -- called "eine Bad Bank" (there is no German word for the concept) -- will not weigh on the budget.

He is fooling them, if not himself. If the rescue really were such a free ride for the taxpayer, some savvy commercial investor would have stepped in. Under the proposed scheme, the taxpayer will end up carrying the risk of "Schrottpapiere" (scrap paper).

Like governments everywhere, the Germans are desperate to get their banking systems moving again -- to save the economy by saving the banks, as British minister Baroness Vadera put it.

The snag is simple. Crystallising all the losses in the banking system might lead to widespread nationalisation of banks -- something most governments are keen to avoid.

But the alternative is equally unpalatable: that the state buys lots of "Schrottpapiere" from troubled banks at unrealistic prices, essentially mutualising all the losses and leaving the banks to keep their profits in private hands.

A German Finance Ministry document seen by Reuters admits this, saying, "Finance ministry examination has shown that in all models, there remains an insurmountable contradiction between the aim of removing assets from the balance sheet and the protection of the taxpayer: if the bank is to be unburdened, the taxpayer has to take on a substantial part of the risk."

The German plan is to allow banks to recognise losses on structured products over their lifetime, perhaps up to 20 years. The government would still guarantee those assets, but would only pay up at maturity if the final value of the assets is less than the "fair value" for which the banks must make provision.

That means any nasties would be pushed out -- certainly well beyond this September's Federal election, and probably one or two beyond that.

By giving the banks time to reserve for impaired assets, it allows them to earn their way out of trouble. And, the politicians get to pretend that there is no damage to Germany's vaunted fiscal stability.

However, it leaves a question-mark over the health of the banks. There is no real severance between the good and bad bank. And the need to build up reserves over a protracted period could act as a drag on the performance of banks -- and their willingness to lend.

It is puzzling why the German government needs to go down this tortuous route of creating special vehicles, with neutral parties to value assets and new accounting rules for reserving.

It is widely acknowledged that the biggest users of the scheme will be the Landesbanks, most of which are themselves owned by regional governments (although some have minority private sector shareholders). They have long been accused of using cheap state-backed credit to provide unfair competition to the commercial banking sector.

That these institutions, created to support regional economic development, ended up buying risky U.S. structured products shows just how far they had strayed from their original purpose. The state could in theory just break them up as it saw fit.

Pushing any assistance out into the future -- and structuring any asset protection on the basis that it can be argued that the shareholders had to take a hefty first whack -- seems designed to obfuscate the scale of any such rescue.

It is always a mistake, as Barack Obama's chief of staff Rahm Emanuel, memorably observed, to let any crisis go to waste.

A better course of action in this instance would be for Berlin to admit that the Landesbank model is broken, insist that their assets be run off over time, and give the private banking system a better chance to flourish when conditions improve.