The essential component needed to prevent chaos if you let failing banks go under

AEI's James Pethokoukis, in the course of pointing out where Timothy Geithner's reasoning behind the 2008 bailout goes wrong, tells us that we'd need to let people keep much more of their own money when situations arose in which we let economic nature take its course:

Geithner is only half right.

He's correct to assume that letting the megabanks collapse — and doing nothing else — might have invited a deflationary depression as bad as the one in the 1930s. Both innocent and guilty would have suffered. And America, like any modern democracy, doesn't really do mass suffering. So the politicians always blink. (Letting Lehman fail was the rule-reinforcing exception.)

But Geithner is wrong when he said, as he did to The New York Times, that Americans are "deeply confused and mistaken" if they think there was "a way to somehow protect people without doing things that looked like you were protecting the banks." Actually, there was an option that would have accomplished just that. There was a way to support Main Street, punish Wall Street, and avoid the terrible incentives for future recklessness that bailouts inevitably create.

Remember, what Washington did in 2008 was authorize the $700 billion Troubled Asset Relief Program. It eventually pumped some $400 billion of taxpayer dough into American financial institutions — whether they wanted the cash or not. The politicians could have let insolvent banks simply go bust. True, such a move would have hammered an already weak economy. To avoid a terrible collapse in spending and investment, however, Washington could have deeply cut taxes or sent tax rebates to households and businesses. How to pay for all those checks? Borrow the money from the Federal Reserve, which, after all, owns the printing presses. Fiscal stimulus meets monetary stimulus.

Some of the money would have been spent, some used to pay off debt, some saved. But the net result likely would have been a far shallower economic downturn, especially if combined with a clear and explicit Fed promise to support spending no matter what. Former Fed Chairman Ben Bernanke recommended just such a "helicopter drop" of money to boost the stagnant Japanese economy back in 2003. Too bad he didn't make the same case to Team Bush and Team Obama five years later.

And what about the banks? For starters, a more modest recession and faster recovery would have limited bank failures. And the assets of the ones that did sink could have been purchased by stronger remaining institutions.

It is always in the interest of a better world to foster the sovereignty of the individual human being.