Now Barack Obama must act pragmatically to fix the banks or the economy will sink under their weight.

Banks continue to suffer losses on bonds backed by failing mortgages, credit cards and auto loans, and questionable corporate debt. To assist, the Treasury Department has used Troubled Assets Relief Program funds to purchase capital in healthy and deeply troubled banks alike; however, no one can calibrate how high bank losses will go, because no one knows how far housing prices will drop and how many loans ultimately will fail.

The Treasury Department could put a floor under bank losses, through government guarantees on their bonds, or by creating an aggregator bank that purchases those securities from banks altogether.

Guarantees would give the banks profits on bonds whose underlying loans are mostly repaid, and shift to taxpayers losses from those bonds whose loans are mostly not repaid. That would require additional large subsidies from taxpayer to the banks.

An aggregator bank, however, could turn a profit. It could purchase all the commercial banks' potentially questionable securities, at their current mark to market values, with its own common stock and funds provided by the TARP. Then the aggregator bank could balance profits on those securities whose loans pan out against losses on securities whose loans fail.

An aggregator bank could perform triage on mortgages. It could work out those whose homeowners can be saved with some adjustments in their loan balances, interest rates and repayment periods; foreclose on mortgages whose homeowners cannot meet payments with reasonable concessions; and leave other loans alone.

Commercial banks acting alone cannot accomplish triage as effectively, because individually they can have little effect on how much housing values will fall. In contrast, an aggregator bank, holding so many mortgages and working in cooperation with Fannie Mae and Freddie Mac, could have a salutary impact on housing values. It could put some brakes on falling home prices.

Beyond toxic securities, policymakers need to fix what got banks into this mess. The 1999 repeal of the Glass-Steagall Act permitted the creation of financial supermarkets, like Citigroup, that combined commercial banks with investment banks, brokerages and the bizarre universe of hedge and private equity funds.

Those non-bank financial firms are run by salesmen and financial engineers who don't understand long-term commitments as bankers to borrowers with solid incomes and sound business plans. Investment bankers, securities dealers and fund managers, essentially, get paid commissions on sales and for betting other people's money on arbitrage opportunities. They put together people who have money with those who need money, and those people who can't bear risk with those who can.

In contrast, commercial bankers, historically, had skin in the game -- bank capital and a fiduciary responsibility to depositors. They were paid salaries, not commissions on the volume of loans they wrote or bought from mortgage brokers to package into bonds. They expected to be fired if their loans proved imprudent.

To investment bankers and securities dealers, it does not matter how risky a loan is, because they can always bundle it into a bond to sell it off or insure it with a swap. That's nonsense, as we have learned. Adopting that thinking, commercial banks got stuck with too many loan-backed bonds and buying swaps that were not backed by adequate assets.

Commercial banks need to be separate and more highly regulated. The ongoing process of breaking up Citigroup and placing its banking activities into a separate entity should be replicated at other Wall Street and large regional banks.

Freed from toxic assets and the complications of affiliations with financial institutions having other agendas, commercial banks could raise new private capital and make new prudent loans as Obama's stimulus package lifts consumer spending and business prospects.

Such approaches would disappoint those who champion unbridled free markets, but Wall Street's financiers have abused the opportunities offered them by deregulation to the peril of the nation.

The president needs to craft solutions that address the world as he finds it, not as intellectuals tell him it should be.

(Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission.)

(United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.)

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