Paulson’s proposal for a Troubled Assets Recovery Plan has raised the question of whether we really need to rescue the financial system. The financial system seems to be screaming “do you really want to find out?” Money market tensions keep rising and spreading, and key measures of dislocation like the TED spread have spiked dramatically over the last few days. One-month and three-month rates have also surged across the main regions, including in various Asian countries.
Money markets are frozen: participants hoard liquidity and banks refuse to lend to each other as counterparty risk has reached new heights. Fears that the TARP might be delayed or watered down in a way that makes it less effective have exacerbated money market tensions even beyond the extreme levels touched a week ago, when the mood in financials markets was apocalyptical.
Assuming that these tensions will have little or no impact on lending and economic growth is a heroic leap of faith, whether you are sitting in Washington, London or Frankfurt. Central bank liquidity injections are an imperfect and temporary substitute for functioning money and interbank markets. While central banks have stepped up their liquidity provisions in the last few days, these dislocations speak volumes about the threats to the funding abilities of banks
