1. The banks as a whole are significantly undercapitalized. The endgame is finding a way to inject private capital back into the banks, which is concomitant with restoring investor confidence in them.
2. There are no "good" answers in the sense that there are no answers that keep the taxpayer off the hook. To quote Alex Tabarrok: "There is no upside. Taxpayers are going to have to pay through the nose but the critical point is that the taxpayers must pay the depositors whom they have guaranteed not the banks."
3. Hence, the objective involves figuring out how to get from here to there while (a) minimizing aggregate government/taxpayer expenditures; (b) minimizing time; (c) minimizing moral hazard; (d) minimizing contagion/panic into healthy companies or economic sectors; (e) maximizing fairness. Some of these objectives are overlapping, redundant, or otherwise positively correlated; others are inversely so.
4. The equation becomes more complicated by leaps and bounds if you add in (f): minimizing political fallout.
5. However, with Geithner having backed off some of the plans that would have entailed greater political risks while at the same time the Republican tolerance for "nationalization" is increasing, the politics are looking substantially less complicated than they did a week ago.
6. Not all banks are in the same boat. Most everyone thinks that Citibank is toast. Most everyone thinks that Wells-Fargo is solvent. (Although even there, concerns exist about its real estate portfolio in California). There is a lot of room between these two goalposts.
7. The Fed probably has some idea about which banks are in which boats, but it probably also needs to have better than some idea before it can plan effectively. Hence, the "stress test".
8. What is commonly being referred to as "nationalization" might be better described as bankruptcy, reorganization, or receivership. The idea (at least the one being floated most commonly by economists) is certainly not for the government to run the banks on an ongoing basis, but to turn them around with deliberate haste and re-privatize them. It's not as though you're supposed to have a JPMorganBernankeCo.gov ATM card sitting in your wallet come 2013.
9. Nationalization/reorganization is as much the default if we can't think of another acceptable plan as it is a plan unto itself.
10. This does not mean, however, that there couldn't be benefits to making a quick, proactive decision to reorganize the insolvent banks. If we're going to reorganize, it would be better to do so sooner rather than later -- and without doing things that waste everyone's time and (more importantly) money in the meantime.
11. The biggest risk of reorganizing unhealthy banks is that it could discourage (although there is debate about this) private capital flow into healthy banks. This could ultimately mean that healthy banks head down the path of reorganization as well, expanding the scope of the problem to the taxpayer.
12. Hence, nationalization is not a "perfect" solution, regardless of any political or ideological barriers. There is still some attraction to identifying hybrid/"creative" solutions that are neither full-blown bailouts nor full-blown nationalization. Some smart people have an inkling about how this might be accomplished, but nobody is really sure.
13. For reasons related to #11, by merely talking about nationalization, Obama/Geithner will tend to make it an inevitability. So if it sounds like they're making up bullshit excuses to avoid talking about it, it's because they are; it is not something they can talk about with full candor until it's something they've pretty much decided upon.
14. Ergo, when and if a decision is made that there is no better alternative to nationalization/reorganization, the wheels will probably move very quickly.