Forget spending and nationalization. We need a Great Restructuring.

There is something desperate about the way economists are clinging to their dogeared copies of Keynes’ “General Theory.” Uneasily aware that their discipline almost entirely failed to anticipate the current crisis, they seem to be regressing to macroeconomic childhood, clutching the Keynesian “multiplier effect” — which holds that a dollar spent by the government begets more than a dollar’s worth of additional economic output — like an old teddy bear…

The delusion that a crisis of excess debt can be solved by creating more debt is at the heart of the Great Repression. Yet that is precisely what most governments propose to do…

So what can we do? First, banks that are de facto insolvent need to be restructured, not nationalized.(The last thing the U.S. needs is to have all of its banks run like Amtrak or, worse, the IRS.) Bank shareholders will have to face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks. Government will take control in return for a substantial recapitalization, but only after losses have been meaningfully written down. Those who hold the banks’ debt, the bondholders, may have to accept a debt-for-equity swap or a 20% “haircut” — a disappointment, but nothing compared with the losses suffered when Lehman Bros. went under.