Kevin Drum and James Surowiecki both take Richard Shelby to task for advocating "closing down" banks."I don't want to nationalize them; I think we need to close them," said the Alabama senator. He wants to "bury some big ones."

For the record, I agree. I think that both Surowiecki and Drum are not being fair to the good Senator. Here's Surowiecki:

[I]t seems clear that what he's advocating is liquidating these troubled banks—shutting them down, paying off the depositors via the FDIC or selling them to another bank (though it's hard to imagine any other bank coming up with the money right now), and then selling off the assets piecemeal, with the proceeds going to pay off as much of the banks' debts as possible. In this scenario, the banks' shareholders would obviously get wiped out, and its creditors would also be forced to take a massive haircut. In effect, he's recommending something like a more orderly version of the Lehman Brothers bankruptcy.

I don't think that's clear at all. The question of whether creditors other than insured depositors are paid off by the government is entirely distinct from the question of whether a bank in receivership should be managed as a going concern or liquidated. There's little dispute that under any nationalization scenario, some or all uninsured creditors would have their claims guaranteed by the state. Whether or not to impose haircuts on junior claimants is a tough call, trading off moral hazard and justice against systemic stability concerns. But even saber-rattling moral-hazard fetishists like me acknowledge that we can't force all creditors of broken monsterbanks to take the losses or debt-to-equity cramdowns they deserve. Sometimes you have to swallow and pay the ransom. But you don't have to be nice about it.

Citi, for example, is a recidivist source of systemic risk (not to mention other corrupt dealings). Three times in three decades it has been on the verge of insolvency and required forbearance. Two of those three times, rather than being chastened, it became a turnaround story someone could gloat about. That shouldn't happen a third time. Citi should be closed and liquidated. The bank should suffer the equivalent of corporate capital punishment, pour encourager les autres. Three strikes.

That doesn't imply that creditors necessarily takes a loss. It doesn't imply that all of its operating assets get sold for scrap, or even that all of its employees get fired. It does imply, first and foremost, that the brand goes away, that Citi, like Continental Illinois, becomes a historical cautionary tale rather than a gigantic but still scrappy comeback kid one more time. Secondly, the pieces in which its assets are sold must be small relative to the buyers, so that successor bits are put under the control of larger firms rather than representing mergers of near equals. Corporate culture matters, and some corporate cultures don't deserve to survive.

Surowiecki has argued on a number of occasions that moral hazard concerns are overstated, that punishing banks usually fails to punish the agents who run banks, and the costs of being punitive outweigh any possible benefit. It's worth pointing out that there are two sorts of villains: governments and creditors who make available funds without supervision, and the bank employees who steal and squander that money. I agree, unfortunately, that we can't be as punitive towards creditors as some of us would like to be. But we can deal more roughly with the people who run large banks aground. We have banking crises about once a decade. Each time, it is the same story: mistakes were made but lessons have been learned. Obviously, the bankers say, we would never do this again. Just as obviously they always do. They play the same basic game in subtly different ways.

In a different post, Drum points out that

The fact is that these people did what they did not because they're stupid, but because the system practically begged them to act the way they did. That's what's broken.

That's true, but it's not exculpatory, and it isn't anything new. Subprime loans and CDOs are just a new twist on traditional real-estate booms. European banks are reliving our Latin American debt crisis in Eastern Europe, just hypercharged. This is a nightmare that comes at us over and over and over again. Each time we've paid the ransom and shrugged it off.

Drum is right when he argues

[Fi]xing it depends mostly on what kind of new financial regulations we put in place going forward. I guess we're still in firefighting mode and don't have time to address that right at the moment, but I'd sure like to start hearing more about it sometime soon. In the long run, figuring out an effective way to regulate leverage, wherever and however it appears, is probably a lot more important than deciding which bureaucratic solution we should use to clean up the corpses currently littering the battlefield.

But you know what? Once the fire is out, the very powerful people who still run the show both on Wall Street and at Treasury, despite having misdirected and skimmed trillions of dollars, will resist structural change. I hope that we do the right thing, and quite sever the guaranteed deposit and payments function of banking from the business of taking investment risk that oughtn't be guaranteed. That would eliminate the root of the problem, the incentive to take ever greater risks with funds supplied on risk-free terms. But getting rid of a huge subsidy to a well connected constituency is likely to prove difficult. If the structural changes don't happen, I'd at least like to see a few of the architects of this mess disgraced, and the empires they built turned to dust. It won't solve the problem, but it might buy us a decade or two. It'd be much better to create institutions whose incentives are aligned with the public interest. But if we can't do that, we can at least counterbalance temptation with punishment. Neurotic banks are better than pathological banks. Consider it a kind of insurance.

If Drum is right that...

when it's over, guess what? Pretty much all the same people will be in charge. A few senior executives will be out of jobs, but that's about it. And the ones who replace them won't be much different.

...then God help us. There is no amount of money we can throw at a banking system that can't be "tunneled" or "looted" away. If we end up with similiar people, with a similar worldview and culture running broadly similar institutions, it won't be long before the nightmare on Wall Street is back. No wonder Citi never sleeps.

We can pay off the creditors of these behemoths, because, by design, we really have no choice. But there's no reason not to cut 'em up and shut 'em down after we do so. Let's bury 'em, Senator Shelby.