[Sweden] took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. We've got thousands of banks.
-- President Obama

Fair enough. Then again, I don't think anyone has called for every American bank to be nationalized. Just the bad ones. In fact, I'd be content with just two: Citigroup (NYSE:C) and Bank of America (NYSE:BAC).

Why? A few reasons. First, Citigroup has $93 billion of tangible equity, most of which is claimed by preferred shareholders, almost all of whom are the government. Bank of America has a market cap of $29 billion, after Uncle Sam pumped in $45 billion of capital. Anyone who thinks these two aren't already effectively nationalized is fooling themselves.

Second, let's be real: What are our other options? First Hank Paulson, and now Treasury Secretary Tim Geithner, have been running in circles for almost five months, trying to craft a plan to purchase toxic assets at some Goldilocks number that's high enough to keep banks intact yet low enough to avoid a taxpayer ripoff of Madoffian proportions.

While we've yet to see exactly what Secretary Geithner has in mind, 2+2 will never equal 1,000, no matter who's in charge. In the end, taxpayers are guaranteed to swallow the amount between what banks need to stay afloat, and what the market is willing to pay for toxic assets. By any estimate, that'll end up as a massive wealth transfer from taxpayers to bank shareholders and bondholders. If Merrill Lynch's $30 billion CDO sale for the equivalent of $0.06 on the dollar is any indication of private thirst for these assets, the taxpayer-to-shareholder wealth transfer could easily approach trillions of dollars.

Anyone in favor of that?

[Cue boos and hisses]

Didn't think so.

Now, this hardly means I'm an anti-TARP-ian. I realize this debate is as heated as it gets, but the $700 billion bank bailout was never a plan to save consumers' love for American Express (NYSE:AXP), nor a strategy to "get banks lending again." It was, from Day 1, a Hail Mary endeavor to halt a run on the banks that threatened the collapse of everyone from Goldman Sachs (NYSE:GS) to JPMorgan Chase (NYSE:JPM), as well as, according to Congressman Paul Kanjorski, "the end of our economic system and our political system" and the entire global economy within 24 hours. Say what you will. I think TARP was undeniably necessary.

But now that last fall's all-out panic has subsided, we need a long-term solution to getting our largest banks back on track. Doing nothing isn't an answer -- they can't survive on their own. Hoping to lure in private capital to purchase toxic assets is fundamentally flawed -- investors can already buy assets. They either choose not to, or banks aren't accepting their bids. "Ring-fenced" asset guarantees are as untransparent as it gets. Hoping legacy management will get right what they've proven spectacularly incapable of brings new meaning to "moral hazard." Our current plans are not, and likely will not, work.

So, what's the solution?

Just bite the bullet already
However the "stress test" the Treasury is toying with works, I have a suggestion: Don't give "contingent capital" to those deemed unstable; give them a contingent funeral. Nationalize them. Wipe out shareholders. Strip them down. Hose them off. Replace management. Fire the board of directors. Quarantine the bad assets. Don't worry about trying to find a "fair price" for assets. Just hold them for Pete's sake. Then, as soon as possible, spin off the stripped-down, streamlined, lesson-learned banks back into the private market. The quicker, the better.

Bottom line
There are several banks that kept their noses clean during the boom years -- including Wells Fargo (NYSE:WFC), BB&T (NYSE:BBT), and US Bancorp -- that will probably make it out alive. There are also a select few that have proven utterly incapable of surviving as private firms. They need to go.

The U.S.'s top economists and politicians spent years criticizing the Japanese for trying to resuscitate zombie banks. Now, we're hoping to avert a "lost decade" of our own by resuscitating a problem that's magnitudes greater, even though we know the catalyst that finally pulled Japan out of its slump was wiping the slate clean and starting anew. It makes no sense.

Nonetheless, we now realize why it took Japan so long. Nationalizing is politically detested and free-market suicide. It's the last thing anyone wants. No one doubts that. Regardless, Japan taught us exactly what not to do. I hope we learned its lessons.

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Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article, mainly because he thinks a few of them won't be around much longer. US Bancorp, JPMorgan Chase, and BB&T are Motley Fool Income Investor selections. Bank of America is a former Income Investor selection. American Express is a Motley Fool Inside Value pick. The Fool owns shares of American Express. The Motley Fool is investors writing for investors.