Today’s Wall Street Journal has an insightful article entitled “Bernanke is Fighting the Last War“. The article is an interview with Anna Schwartz who “may know more about monetary history and banking than anyone alive.” Schwartz’s viewpoint is that the current crisis is being treated as a liquidity or lending crisis when in fact it is an asset crisis. The problem in this case is exotic securities that are toxic because no one knows how to value them. The “dirty little secret,” says Schwartz, is that had Treasury Secretary Paulson proceeded with his original plan to buy up these assets at market prices many banks would have failed as a result. So instead, Paulson shifted to re-capitalizing the banks themselves. Yet because this avoids punishing bad decision-making it may merely prolong the crisis. The answer, suggests Schwartz, is rather to let bad banks fail. In other words: stop trying to defy gravity. Let’s hope we don’t spend another $700 billion (or even more) before learning our lesson.