In what I think was President Obama’s first substantive error (not including the easily fixed nominee battles), his Treasury Secretary Tim Geithner offered an outline of a financial plan that skirts around the main problem facing the financial system. Geithner’s plan is based on three parts:

1) Give $50 billion to homeowners struggling with foreclosure. Details on this will come later but it is, in my opinion, a necessary element.
2) Institute a “stress test” to determine which of the remaining banks are insolvent. If they are found to be insolvent, then…
3) Establish a public-private entity to swallow up the bad assets and sell them later

Some critics charge that this is just Paulson redux. I don’t think that’s entirely fair; Paulson was openly hostile to aid to homeowners, and he quickly abandoned any plan to buy up toxic assets.

The heart of the problem, however, is this: how do you price those toxic assets?

Geithner seems to be calling in the vulture investors to buy up this junk as they have done before.

But the vultures are unwilling to do so at this point because the banks won’t sell the bad assets at their true bargain-basement value.

As economists realize, somebody must buy these toxic assets from the banks if they are going to lend again. Geithner’s public-private plan is vague on who those people are, and, more importantly, how they would price those assets.

in fact, the deeper problem is that the toxic assets have infected and rendered insolvent the entire financial system. It isn’t buyers who cannot be found. It’s sellers: the banks don’t want to sell at market prices because then they would have to take a massive loss on their books and be revealed as utterly insolvent.

Consider these numbers: Citigroup has around $1 trillion in assets, but only $18 billion in equity. Bank of America is worth only $28 billion.

As Nobel economist Joseph Stiglitz argues: the banks are already insolvent and just don’t want to admit it. If the housing market dropped one percent more, those 18-28 billion would fall to zero and the gig would be up officially.

Why, then, does Secretary Geithner continue to insist that a public private partnership can somehow coax the big banks to sell their toxic assets at a price that won’t rob taxpayers? Because he’s afraid of nationalization.

President Obama was asked about nationalization and claimed that Sweden could get away with it because Sweden only five banks, unlike our large system. But the problem in America is limited to about six major banks – all of which are facing or in total insolvency.

It’s time to face up to facts: the financial system in this country bet everything on bad loans and lost. Now it’s time for the government to take over the banks, wipe out the bank investors, fire the management, sell the toxic assets at bargain basement prices to the vultures, and then release the cleaned up banks to the market again. Call it “reorganization” or “receivership” if nationalization sounds too radical. Either way, that’s the only way out of this mess.