In the continuing saga of market meltdowns, central banks throughout the world are pumping liquidity into the financial markets at a rapid rate. And yet analysts continue to talk about "credit seizure" and use similar terms to describe the reluctance of commercial banks to lend to each other or to provide short-term working capital for many of their customers.
At the same time, as the central banks buy gubmnt debt to carry out their plans to increase liquidity, the commercial banks, leery of just about any financial investment, are also buying short-term gubmnt debt. The result is that many, many people are increasing the demand for t-bills and gubmnt bonds, driving down the interest rates on those securities.
Meanwhile they are reluctant to lend anywhere else, even at much higher interest rates. Hence the spread between t-bill rates and interest rates on other short-term loans has grown rapidly, a sign that lenders are confused/pessimistic/lacking in trust about the credit-worthiness of the borrowers.
So as the central banks try to pump up liquidity, it all seems to disappear into t-bills and the like. Only when lenders get a better idea of the nature and soundness of different borrowers will this liquidity find its way back into the commercial markets.
Update: As Craig Newmark says this morning,
...[P]art of the current problem seems to be that banks are hoarding cash. And part of the reason for that may be that they are waiting for settlement of the derivative securities created by Lehman and other failed firms. Supposedly, Lehman securities will be settled this Friday, and the Feds are working on creating a central clearinghouse.
Those things may help, but don't, on my account, bet on it.
Update #2: Kip Esquire in the comments points to this detailed analysis by Jim Hamilton. Look at his graphs! Wow!
Econbrowser has the graph of exploding bank reserves at the Fed -- it's astonishing.
Posted by: KipEsquire | October 08, 2008 at 07:10 AM