Governments and central banks have moved to remove toxic debt from bank balance sheets, inject share capital to cover losses from bad debts, and also guaranteed the bank’s own borrowings to allow them to continue to raise deposits and receive loans. Bank of England Governor Mervyn King recently summed up the nature of the UK’s support for the banking system memorably: "The package of measures announced yesterday by the Chancellor are not designed to protect the banks as such. They are designed to protect the economy from the banks."

Governments have provided large amounts of fiscal stimulus and support for the housing market (in the US). In addition to the normal "automatic stabilizer" effects of reduced tax income and higher social welfare spending in a recession, governments have launched new spending initiatives focused on infrastructure and direct payments to those most affected by effects of the GFC. Central banks have cut interest rates to levels not seen for decades.

In January 1971, Richard Nixon recanted years of opposition to budget deficits declaring: "Now, I am a Keynesian." It seems that we, are once again, all Keynesians. Writing in the Financial Times (February 5) Benn Steil, Director of International Economics at the Council on Foreign Relations, succinctly set out current economic thinking: "When the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes."

Governments and central bankers have become frustrated at the failure of policy actions to help the resumption of normal financial activity. Where governments have taken substantial stakes in banks, there is a noticeable drift to "directed lending." Central banks and governments are increasingly bypassing the banking system -- TARP handouts to JPMorgan (JPM), Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) notwithstanding -- and providing finance directly to businesses. The Federal Reserve may soon issue credit cards to all Americans under its own brand.

It is not clear whether the actions taken will have the intended effect. As John Kenneth Galbraith noted: "In economics, hope and faith coexist with great scientific pretension."

King Canute Addresses the Waves

The financial initiatives have not led to a significant easing of credit conditions. This reflects the fact that the capital provided is only sufficient to cover continuing losses but insufficient to restore normal lending and financial activity.