She says that the basic problem is that we don't know how to value these toxic assets. If we value them at the current market price, it would mean many banks are insolvent (euphemism for broke).

So buying up toxic assets is not incompatible with letting banks fail; if we pay market price, purchasing these assets may reveal a number of banks who are broke by removing unknowns from their balance sheet.

By switching to recapitalizing (euphemism for giving them money), we make no progress in removing unknowns from the balance sheet. This is why we're hearing about banks who are hoarding the capital instead of lending it -- they still don't know if they're broke or not.

There was a good article posted here a couple of days ago (can't find the link now) that argued that the difference is that the government can afford to buy the assets at above the market rate, because they can take a long-term view and hold them to maturity. The banks can't do that, though, they must value at market value and need to be able to trade them at a reasonable rate. The question then, of course, is how to estimate the hold-to-maturity value.

Buying them up at market rate, as you say, would just make all the businesses fail. The whole problem is that the market value is almost certainly not an accurate indicator of the intrinsic value of these investments at the moment.

But why does the government need to get involved then? Let the market determine market rates which is only determined by actual transactions. Most likely someone in the market will buy the toxic assets, but not for face value. Because of the uncertainty, someone may only pay $0.10 on the dollar. The financial firms, however, are waiting to see if they can get a better deal/hand-out from the government.

If the government made it clear that these businesses were on their own, then they would be forced to sell the assets at market rate, i.e. the amount the market is willing to pay for them.

If that's not enough, then as Anna implies, then they deserve to fail.

I certainly agree that the market should determine the value of the assets, even if they turn out to be worth 1/10th of what the banks would like them to be worth -- that's life.

The problem is that if the banks don't like the market price, they don't have to sell. As long as they hold the assets, the credibility of their balance sheets may be in question, but why sell the assets for cheap and prove their own insolvency. As I understand it, this is the current gridlock.

the lehman credit-default swap (cds) auction a week ago friday (oct 10) brought 9.75 cents on the dollar:

http://blogs.wsj.com/marketbeat/2008/10/10/lehman-bonds-pric...