Bailout: "Oh Come On. What's the Worst that Could Happen if Congress Does Nothing?"

William Buiter was a member of the Bank of England's Monetary Policy Committee, 1997-2000. He is currently Professor of European Political Economy at the London School of Economics. He tells scary stories as well as Stephen King. From the Financial Times:
Those whom the gods would destroy, they first make mad

... If the markets fear that the nays have thrown their toys out of the pram for the long term, the following scenario is quite likely:

• The US stock market tanks. Bank shares collapse, as do the valuations of all highly leveraged financial institutions. Weaker versions of this occur in Europe, in Japan and in the emerging markets.
• CDS spreads for banks explode, as will those of all highly leveraged financial institutions. Credits spreads generally take on loan-shark proportions, even for reputable borrowers. Again the rest of the world will experience a slightly milder version of this.
• No US bank will lend to any other US bank or any other highly leveraged institution. The same will happen elsewhere. Remaining sources of external finance for banks, other than the facilities created by the central banks and the Treasuries, will dry up.
• Banks and other highly leveraged institutions will try to unload assets at fire-sale prices in illiquid markets. Even assets not viewed as toxic before will become unsaleable at any price.
• The interaction of a growing lack of funding liquidity and increasing market illiquidity will destroy the banks’ business models.
• Banks will stop providing credit to households and to non-financial enterprises.
• Banks will collapse, both through balance sheet insolvency and through liquidity insolvency. No bank will be safe, not even the household names for whom the crisis has thus far brought more opportunities than disasters.
• Other highly leveraged financial institutions collapse on a large scale.
• Households and non-financial businesses revert to financial autarky, among wide-spread defaults and insolvencies.
• Consumer demand and investment demand collapse. Unemployment shoots up.
• The government suspends all trading in financial stocks until further notice.
• The government nationalises all US banks and other highly leveraged financial institutions. The shareholders get nothing up front and have to wait for an eventual re-privatisation or liquididation to find out whether they are left with anything at all. Holders of bank debt get a sizeable haircut ‘up front’ on the face value of the debt and have part of the remainder converted into equity that shares the fate of the old equity.
• We have the Great Depression of the 2010s....MORE