For the third time in the post-war period, the United States banking system is insolvent. When President Barack Obama's economic advisor Paul Volcker chaired the Federal Reserve's Board of Governors in 1981, the collapse of emerging-market borrowers left the big American banks on the verge of bankruptcy. The collapse of the junk-bond market in 1990 followed by the real estate market in 1991 left the system insolvent once again.

Both times, the right medicine was to ignore the disease. Rather than mark banks' asset books to market, the Federal Reserve let them carry bad loans at face value. By dropping interest rates, the Fed provided cheap funding for the banks to earn a higher margin on their assets. As long as cash-on-cash returns were positive, the regulators could ignore the insolvency.

Today's problem is far worse than the previous two system insolvencies, to be sure. It is so large that nationalization the banking system very well might crush the …