Simultaneously, banks gave preference to shedding assets outside their national borders, and risk managers try to match assets and liabilities at home, rather than within the eurozone as a whole.

Government subsidies for private bad banks, or public bad banks to clean up private banks toxic assets, are a bad way for taxpayers to transfer money to troubled banks compared to normal capital injections.

A bad bank can be an effective instrument in the recovery of losses and the revival of banks.

A full scale financial crisis is triggered by a sharp fall in the prices of a large set of assets that banks and other financial institutions own, or that make up their borrowers financial reserves.

The US Troubled Asset Relief Program (TARP) was an opportunity to force banks to disgorge bad assets and thus repair the credit pipes.

But higher interest rates also imply large capital losses for central banks asset holdings.

(a) The balance between equity type assets and other assets, such as bonds

But turning them over to the government at market value doesn t improve banks balance sheet to do that requires overpaying for the assets, a transfer of wealth from ordinary taxpayers to the banks..

European and other international banks had acquired a lot of dollar denominated assets which they habitually funded in the interbank market as the market dried up, they were forced to buy dollars.

Because all the derivatives were based on the same assets, if anything happened to those assets, all the banks holding the debt would find themselves in the same soup.

Furthermore, the point was not to help private banks get rid of their troubled assets.

It may pile up in bank reserves or savings accounts, or it may produce asset bubbles.

Their central banks can borrow and use the money to buy up some of the flood of risky assets in the market.

The inter bank market dries up, as banks lose trust in one another.

Banks in the eurozone came under pressure, and interbank tensions increased.

Banks have less debt relative to their equity levels than they had in 2007.

The old NPL problem was resolved, primarily by establishing asset management companies to take over doubtful assets, and injecting new capital into the commercial banks.

Some will say that Baltic and Southeast European countries were fortunate that responsible Swedish and Austrian banks, rather than their toxic US and British counterparts, had entered their markets.

By offering to lend freely against collateral, they liquify assets and prevent banks from being forced to unload loans or securities at fire sale prices.

Banks defenses need to be fortified during excessive upswings in asset prices so that they are able to weather the inevitable reversals.

Banks are highly leveraged institutions with relatively small capital bases, so even a relatively small decline in the prices of assets that they or their borrowers hold can leave them unable to pay off depositors, no matter how long the liquidation process.

Banks often oppose higher equity asset ratios, because equity capital is more expensive than debt capital. But this is precisely because of the lemon effect.

Under an international agreement known as Basel III, banks are to be required to hold a higher ratio of equity capital against risk weighted assets, and leverage is to be limited to a smaller percentage of such assets.

But such revisions of Basel II are not enough, because bank portfolios especially those of international banks with large trading books are vulnerable to the risks stemming from long swing fluctuations in asset markets.

Even central banks, especially the US Federal Reserve, have been supporting particular firms and types of assets because of the financial crisis.

Stock and housing prices may be volatile, but the data are much cleaner and timelier than anything available for output and inflation. This is why central bankers must think about the information embedded in asset prices.

Low interest rates on deposits encourage savers, especially households, to invest in fixed assets, rather than keep their money in banks.

Central banks should influence asset prices through normal open market operations by buying and selling short term government securities for cash, thus changing the safe interest rate and the price of longer duration assets

Will banks be willing to part with the assets at a low enough price to attract private investment? And would doing so force larger write downs, requiring banks, in turn, to ration credit and thus harming the economy?

The Fed simply failed to comprehend the significance of traditional banks large holdings of mark to market assets and their own engagement in shadow banking via off balance sheet structured investment vehicles.

Regulations everywhere appear to be based on the false notion that banks should have just enough equity.

For example, the Troubled Asset Relief Program (TARP) originally targeted the purchase of complex securitized assets that had lost value and stopped trading, but had to be partly altered to direct infusions of capital into banks.

They diversify their funds among different currencies and different types of financial assets.

Instead, banks were obliged only to take equity injections from the government, which they consider politically toxic.

Central banks should influence asset prices through normal open market operations by buying and selling short term government securities for cash, thus changing the safe interest rate and the price of longer duration assets

Treasury Secretary Timothy Geithner s new public private investment program to buy toxic assets has few takers, despite subsidized non recourse financing. So the toxic assets remain on bank (and other) balance sheets.

If banks and financial institutions find it difficult to recapitalize (i.e., issue new equity), it is because investors are uncertain about the value of the assets in their portfolios and do not want to overpay. Will government do better at valuing those assets?

The connection between financial risk and asset price swings emerges from the use of a new approach Imperfect Knowledge Economics (IKE) to understanding risk and fluctuations in asset markets.

Minimizing the fluctuation between assets and the present value of liabilities requires matching the characteristics of liabilities with assets with similar characteristics and adjusting for inflation.

Assets in the oil industry, on the other hand, were divided among several companies.

Similarly, banks have short term liabilities (deposits) and long term assets, which they cannot liquidate quickly without incurring great losses.

Of course, it is difficult to imagine that banks will use all of the money to buy the same assets that some of them have been trying to sell over the past few months.

General deflation eliminates the capital of yet more financial intermediaries, and makes risky an even larger share of assets that had previously been regarded as safe.

But how can we distinguish good banks from bad?

Improved central bank policy is another huge factor.