This is much like what we did in the US about the S&L Crisis but haven't done relatively much about the Great Recession and its aftermath (Are we still paying for that as a mistake and will be for a long time to come?):
For prudential policy, it means repairing banks’ balance sheets aggressively through the full recognition of losses, asset disposals, recapitalisations subject to strict conditionality, and the reduction of operational excess capacity necessary for sustainable profitability. This is what the Nordic countries did and what Japan failed to do following the bust in their respective financial cycles in the early 1990s; it is what partly explains their subsequent divergent economic performance.
For fiscal policy, it means creating the fiscal space needed to use the sovereign’s balance sheet to support private-sector balance-sheet repair while avoiding a sovereign crisis down the road. This can be done through bank recapitalisations, including via temporary public-sector ownership and selective debt relief for the non-financial sector (eg. households). In fact, contrary to received wisdom, pump-priming – where it can be afforded – may well be less effective in a balance-sheet recession, as agents tend to save the extra money to repay debt, resulting in a low multiplier. By contrast, by relieving debt burdens and asset-quality problems, the alternative use of fiscal space could set the basis for a self-sustaining recovery.
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