It’s been difficult getting comfortable with recapitalization of US banks as the better solution. There are a few structural elements that don’t sync well with securing and restarting a stalled credit system, which is central to any restoration and improvement of our economic model.

Recap’s momentum had two drivers. First, Europe had already announced it and the US policy makers believed our banks would be at a competitive disadvantage without implementing the same program, from both the perceived stability of our banks as well as having huge new capital to invest with.

Second, there would be a favorable multiplier effect to the action. The historical bank lending-to-capital ratio of roughly 10-1 would put $2.5 trillion into economic circulation for only $250 billion of TARP funds (~ 1/3rd of appropriations) .

The trouble with this view is the banks are broken. It’s not reasonable to conclude the historical 10-1 leverage of capital can or will be implemented within the window of opportunity that exists for it to put a net under the US economy. Global invested funds are currently undergoing a contraction (not expansion), as money is pulled from all but the surest vehicles. Look to the exit of money from emerging markets for an example.

The recap approach also leaves the damaged financial instruments right where they were, on balance sheets with worthless valuations because no one will buy them. There is substantial performance occurring on many of the instruments but they cannot be sold because there are no willing buyers.

The principal reasons are further erosion of mbs performance is not estimable and the instruments are not accepted as collateral from counterparties. In both cases the markets are unable or unwilling to divine a genuine cash flow and risk based model for their valuation.

If left as they are, the mbs’s are likely to remain in this state in perpetuity. Global markets have finally begun to understand there is a severe contraction in demand underway and they don’t have any benchmark for charting forward demand for goods & services. From the standpoint of mbs’s, this means the underlying mortgages are at further risk of default as business protects its assets and earnings from lost revenues, through head count reductions, taking away borrowers means to pay.

With the recap model, we’ve just given a staggering sum of money to banks that could not properly manage what they already had and you bury hundreds of billions of dollars in value (mbs) as a worthless line item on the balance sheet.

In practice, the banks have earmarked the federal funds for capital preservation or talk of using the recap funds for acquisitions, which makes things worse. As Federal Reserve Chair Bernanke observed and I’ve blogged, we’re kidding ourselves if we allow a handful of banks to carry 50% or more of US deposits & loans.

That concentration is a bomb with a short fuse that has the capacity to bring greater trouble than what is transpiring currently. And you are allowing it in an industry that has twice undertaken catastrophic lending strategies in the last 20 years (S&L commercial real estate failure included).

It leaves you feeling the recap strategy is testifying that the risks to stability are expected to remain strong and consolidation is seen by policy makers as sandbags around depositors.