Thursday, October 9, 2008

Guarantee for the Interbank Market?


Yes, good idea. But, as we've been (smugly) pointing out, think about what will happen if you are "wrong".

The implementation of the Treasury's new authority under TARP is weeks away, and rightly so. This means that, in the interim, the Fed could step up and say, "we'll carry the bag, paper over the problem, until the big medicine man comes", we'll guarantee the inter-bank market for these types of paper ... for a short, indefinite term, not less than 90 days.

Now, suppose the Fed did this, yet the inter-bank lending rates did not come down. Since credit / counter-party risk has been removed from the equation, the observed rates will be a measure of the true unwillingness to lend, a true measure of the "credit crunch".

Knowing that might help policy makers calibrate their next response(s), but such an outcome would not immediately reassure the markets (it might even spook them, given how some economists wing-flap). Together, that implies that the confidence-building benefits of such a clever move ought not to be oversold.

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