It makes no sense to try to get private equity involved in leverage purchases of assets under TALF. As Warren Buffett told CNBC earlier this week, “the interesting thing is that the toxic assets [of American banks is] if they’re priced at market, are probably the best assets the banks has, because those toxic assets presently are being priced based on unleveraged buyers buying a fairly speculative asset. So the returns from this market value are probably better than almost anything else, assuming they’ve got a market-to-market value, you know, they have the best prospects for return going forward of anything the banks own.”

Why is Treasury Secretary Geithner so eager to get the stuff off the banks’ books, while the Sage of Omaha wants to get more of them onto the books of banks in which he invests? It has to do with the academic obsession with bank lending that afflicts Geithner as well as Larry Summers. They want the banks to lend more to the economy in order to stimulate economic recovery. This is perfectly ridiculous because no-one wants to borrow. Everyone with two synapses that fire in the same direction wants to pay down debt.

Buffett is thinking about the value of his investments, not about the macroeconomic significance of Wells Fargo. What Summers and Geithner haven’t absorbed is what a friend of mine who manages an enormous insurance portfolio worries about. The banks, he fears, have gotten themselves into such a hole that they will wear through their capital structure, starting with the preferred stock that Citigroup just proposed to turn into equity, and thence up the capital structure to subordinated debt and so forth. In the process, the necrosis in the bank capital structure will kill the insurance industry, just as AIG warned in a memo to Congress posted on the Financial Times website.

It’s not about getting a recovery going. That’s not going to happen, not if Martians land in flying saucers with a billion tons of gold to invest in bank capital. It’s about preventing something worse than we have now, namely screaming, bug-eyed, blood-in-the-streets, rape-the-crops-and-burn-the-women panic. Zombie not bad. Zombie good. Zombie better than alternative, which is you dead. Really dead. No breath, never get live again. Zombie is as good as it gets. You zombie, you still alive, sort of. You not zombie, you dead. Opposite of zombie not happy, lively, active. Opposite of zombie is you push daisies up. The best we can get out of this is a zombie banking system, one that still pays its debts because it earns enough interest from the toxic assets left over from the last boom.

Private equity is so burned out after years of losses on structured product that the pension funds and insurers who bankroll the likes of Blackstone and Kravis have had enough. Bloomberg has a good deal of information on the body count today, including this report:

March 13 (Bloomberg) — Investment funds that purchased a majority of the lowest-rated loans during the credit boom have stopped buying, threatening to undermine President Obama’s plan to pull the economy out of the worst recession since 1982.

The funds, known on Wall Street as collateralized loan obligations, provided cash to movie-rental chain Blockbuster Inc., which is now exploring a bankruptcy filing, according to a person familiar with the situation. They also helped finance the $33 billion buyout of Nashville, Tennessee-based hospital operator HCA Inc.

Now, as an economic slowdown drags into the 16th month, borrowers unable to pay their debts are causing record losses for CLOs. Moody’s Investors Service put 760 of the funds, holding about $440 billion of assets, on review for downgrades on March 4. Unless policymakers decide to earmark some of the $11.6 trillion of government programs created to combat the seizure in credit markets to support high-yield loans, defaults may soar through 2012, according to investors.

“The game is over,” said Ross Heller, managing director at New York-based NewOak Capital LLC, an investment and advisory firm. “There isn’t going to be money available for refinancing. Companies will have to be put into bankruptcy and the debt restructured.”

As credit losses have climbed, issuance of so-called leveraged loans in the U.S. plummeted to $11.7 billion in January and February from $66.3 billion in the first two months of 2008 and $158.7 billion for the same period in 2007, according to data compiled by Bloomberg.

The private equity people I talk do simply do not think that Geithner’s leveraged asset idea will work. Geithner and Summers are the Laurel and Hardy of public policy. When things get tough the President will ask the grownups (Buffett, Volcker, Bernanke) what to do.

And that’s just what Bill Bradley told Bloomberg television today.

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