Fed Policy Alternative: Watch The World Burn (GS)(JPM)(FNM)(FRE)(WB)(WM)(LEH)

In the latest installment of the "Batman" film series, loyal butler Alfred tries to explain the behavior of some of the most depraved criminals. He points out to a befuddled Bruce Wayne that "Some men just want to watch the world burn."

To counter the Bernanke argument that the Fed must step in to save banks and financial institutions which are deemed "too large to fail", Willem Buiter, formerly a Bank of England policy maker, said that a willingness to bail out distressed investors is “unhealthy and dangerous.

Several proponents of a minority report, including men as august as Warren Buffett, believe that it is irresponsible to do much of anything for troubled banks. The system will get the heroin out of its blood if it has to go cold turkey immediately.

No one can predict the level of disaster that would follow a withdrawal of the Fed as the critical support of the US financial system. Optimists believe that healthy firms like Goldman Sachs (GS) and JP Morgan (JPM) would buy up their failing peers. The bleeding would be limited and a natural consolidation would occur.

The notion that the financial system could "fail" successfully does not make much sense once the analysis steps beyond the best case. Goldman Sachs may not hold relatively as much bad paper as Lehman, but serial failures of Lehman (LEH), Wachovia (WB), and Washington Mutual (WM) may be more than the support beams of the healthy institutions can handle. Coupled with a catastrophe at Fannie Mae (FNM) and Freddie Mac (FRE), it is almost impossible to see how anything other than profound instability would prevail.

The government may have become meddlesome over the last year and it may undermine the strengths of a free market system.

But, chaos has its disadvantages.

Douglas A. McIntyre