Everything is frozen. Banks do not lend money to each other, only overnight and at very high rates. Corporates cannot refinance their commercial paper, so Fed will buy CPs. If Fed also moves into unsecured lending to banks (as reported by some sources) it would be a truly dramatic decision. Why would you borrow from interbank market at very high rates, borrow from Fed cheaply. Why lend to another bank and take the counterparty risk, park liqudity at the Fed and sleep well. Why sell “toxic” assets at dirt cheap prices to the market (nobody wants to buy anyway) sell to government dear and make a buck.
Would all this together work and help restore confidence? Well, I saw reports predicting that housing market will drop by another 20-25% in 2009, so bank losses will continue to grow. US recession which now seems inevitable would lead to “traditional” loan portfolio deterioration, with further losses. My guess is that fear and lack of trust will remain with US banks for quite some time. Therefore the only action could be between Fed and banks, while interbank market will remain frozen. Siberia finance. This will last as long and banking sector capital reamin low and is being depleted by continuing losses. I think that the best way to improve US banks credibitlity is to sell them to Chinese or Arab capital-rich investors, if they want to buy. I think that there exists a share price that will clear US banks demand for capital and Asian/Gulf supply of capital, now invested in US Treasuries. A mega-swap could delived a warm, spring wind of change to frozen markets.