Some people rather experience an extreme loss in employment but rapid gain in employment, instead of a slow misery that last for a decade. By defaulting banks, we could reallocate resource quickly as banks' assets get sold to healthy banks.
Rather than trying to avoid pain, we should acknowledge failure as a part of a healthy free market system and optimize for a robust system that can handle failures instead of having "too big to fail."
It should be like when circuit-city falls, there isn't much damage to the economies, instead of the fear that comes from when financial institutions are failing.
One obvious solution is outlaw "too big to fail" although that seems to be hard (the current US financial regulation bill enshrines them), and it still doesn't address the lemming like behavior you see in bubbles which allow near total systems failures.
In fact, wasn't the US banking system of the '30s mostly comprised of small banks (as I recall, 8,000 of them had failed when FDR closed the rest, but my memory of that number could be off or maybe that was the total???).
Rather than trying to avoid pain, we should acknowledge failure as a part of a healthy free market system and optimize for a robust system that can handle failures instead of having "too big to fail."
It should be like when circuit-city falls, there isn't much damage to the economies, instead of the fear that comes from when financial institutions are failing.