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

There is one law, it appears, for failing U.S. automakers but sadly quite another for similarly failing banks.

The Obama administration has decided to play hardball with auto firms; rejecting recovery plans from General Motors and Chrysler LLC (GM.N) and warning they could be thrown into bankruptcy. Chrysler, which is controlled by Cerberus Capital Management CBS.UL, has 30 days to complete an alliance with Italy’s Fiat SpA (FIA.MI) or face losing its government funding. GM chief executive Rick Wagoner is out at government request, as will be most of his board of directors in coming months.

This is painful and risky but probably for the best; the auto industry has far too much capacity and both firms have blundered repeatedly, avoiding making hard decisions to improve their competitiveness and products. In short, this is what is supposed to happen in capitalism when you fail.

It is also a huge contrast to what is being done for U.S. banks, where management has generally remained entrenched and where Treasury Secretary Geithner and his predecessor have thrown cheap money and other subsidies at doubtful banks in ever more complicated forms. Most recently, going as far as cutting hedge funds and other investors into the deal under the public private partnership in order to create the illusion of a return to market forces.

If the U.S. administration thinks the auto tough love will make them look like they are taking a hard line with highly compensated executives, they could not be more wrong. If anything it will increase the perception of the divide between how Main Street and Wall Street are treated when they come begging at the public trough.

To be fair, the case against the automakers is pretty airtight. Even given a recovery, which is by no means a sure thing, they may not be viable. The best counterargument, that bankruptcy causes rolling failures among suppliers and that consumers will shun automakers which are in bankruptcy. Those possibilities are hard to measure, and even if true, probably not enough to justify keeping the two on life support for what could be an indefinite period.

IT’S DIFFERENT FOR BIG BANKS IN TROUBLE

So what accounts for the difference in treatment, given that many banks, large and small, are both insolvent and dependent upon government support for their continued existence?

There are some legitimate reasons but they quickly bleed into special pleading and moral hazard. The entire economy is dependent in substantial part on the health of the financial system which intermediates capital, theoretically allocating it (insert ironical remark here) where it will make the best return.

That makes it harder for policy makers to simply allow banks to fail and for the industry to find its right size, the damage in the meantime would be too great. That gives large overleveraged banks a strong negotiating position with government, even in their weakness. That’s unacceptable and needs to be dealt with now, by treating them on their merits, rather than later through regulation to control the size and leverage of institutions.

There is a real risk that we get the worst of all worlds; the banks are kept alive and make it through with management in place and are able to use their obvious influence and might to deflect legislation. We then have a system with moral hazard at its heart and another larger crisis heading our way after the next bubble.

It is striking that the guy leading the enquiry into the viability of the automakers is former media investment banker, financier and private equity investor Steven Rattner rather than an auto person. Quite right too, someone who has lived and breathed this stuff is conflicted and won’t have the proper perspective.

But what a contrast with the number of once and future investment bankers (former Goldman Sachsite’s Neel Kashkari being exhibit A) involved in the government side of the banking bailout. After all, who else could understand this stuff? Don’t Trouble Your Pretty Little Head about that, as they used to say down south.

There is an alternative, after all. Rather than constructing a bank bailout which is essentially the Resolution Trust Corporation but missing out all that messy stuff about banks failing and executives getting canned, why not simply impose tough capital limits, fail the banks and executives that fail and come up with a reasonable timetable for selling on what you are left holding?

It has two great advantages; it has worked, both in the U.S. and around the world, and it is fair and easy to understand as fair.

Rescuing the economy and the banking system, as opposed to the banks, is going to require more government money. The favorable treatment of banking executives and shareholders may make that money very difficult politically for the administration to get.

– 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 –

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

Some crises bring partners closer together. Some, as investors in the euro zone are likely to discover this year, drive them further apart.

Look for rising tensions about fiscal and monetary policy among the bloc’s 16 member nations, and for a bigger penalty to be imposed on the euro and some euro zone assets against the possibility of a breakup or a secession from the currency group.

The liquidity crisis of last year left smaller members of the euro thanking their lucky stars they were inside a big warm tent with a major currency and critically, a powerful central bank that could help banks and maintain order in financial markets.

Ireland and Greece, to name but two, could look at the disaster in Iceland, which suffered a banking and currency collapse, and see the real tangible benefits of membership.

But now that the crisis has morphed into one in the real economy, with exports plunging and employment hit, things will be less cohesive within the euro zone, with one currency having to do duty for different countries with different economies and levels of competitiveness.

European governments vary widely in their ability to withstand the fiscal squeeze from falling tax receipts, as well as having varying ability to credibly take on programs of stimulative deficit spending. That of course is about all that euro countries have open to them when it comes to unilateral action, being forced as a condition of membership to live with a common currency and interest rate policy.

The ECB is widely expected to cut rates by a half a percentage point on Thursday, to 2.0 percent, a level considerably higher than the ideal for many hard hit smaller economies.

The implication is weakness for the euro, as investors impose a breakup premia, and more weakness for the bonds of smaller peripheral countries.

Standard & Poor’s on Wednesday cut Greece’s sovereign debt rating, citing falling competitiveness and a rising fiscal deficit. S&P has also threatened the credit ratings of Ireland, Portugal and Spain on concerns about deteriorating public finances.

The extra interest Greece must pay to borrow money for 10 years as compared with Germany stands at 246 basis points, while for Ireland the figure hit 180 basis points, also a record, and spreads have widened too for Spain and Portugal. Coming at a time of low interest rates, with German 10-year debt yielding just over 3 percent, these are whopping premiums for debt that theoretically should be very tightly related.

CHEER UP, IT MIGHT NEVER HAPPEN
To be clear, the chances of a country leaving the euro zone currency project are still extremely small, though it now rates as a possibility for discussion in polite company.

For one thing there is no escape hatch, no plan as to how a national currency might be reborn. For another, there is the matter that while a bit of a weak currency and an accommodative interest rate might seem attractive at first blush, the reality would include much higher interest rates and the real risk of a Latin-American style inflation and currency crisis.

“Put very simply if either Greece or Italy, for example, left, the sort of spreads they are trading on at the moment would have to treble,” said Marc Ostwald, strategist at brokerage Monument Securities in London.

“There would be colossal inflation in both countries as a result.”

It would also be extremely tricky to pull out without very seriously impairing your national banking system, though that impairment may come of its own momentum anyway, conceivably as the flash point for a break-up. But just because something is a dumb idea doesn’t mean it won’t be advanced as reasonable.

There are other issues causing problems for countries with smaller bond markets. Investors are generally showing an almost unprecedented preference for stuff that is easy to sell, and German bonds are just a lot more liquid.

You can also argue that the kinds of very narrow spreads we saw before the crisis were simply one more manifestation of the headlong search for yield, and that some but not all of the re-pricing is warranted as a reflection of the new reality.

There are a couple of bitter ironies here for the euro zone. The world has probably never needed an alternative reserve currency more, with natural demand likely to rise for liquid, safe non-dollar assets given U.S. imbalances and monetary policy experiments.

It is also a bit raw that the downturn that will test the euro zone is not of its making. Its consumers by and large didn’t gorge at the debt feast and savings rates remained on the whole higher.

But that is cold comfort and no assurance the price of the risks of euro disintegration won’t rise further.

– 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.