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No. of Recommendations: 7

This is a nice example of how the liquidity crisis does have tenticles. A bank which is not overexposed is having trouble meeting cash flow because of lack of money available to borrow in capital markets.

What I read, in between the lines, is the fundamental unsoundness of the whole lending system. I'll let Kent or Dr. Tarr explain why I'm completely wrong, but...

Traditional banks borrowed money from savers to lend to borrowers and paid expenses and made profits from the difference in yields (e.g., they pay me 5% on a CD and get 6% on a car loan). Under the circumstances, the profits are going to be limited, especially as both savers and borrowers can shop around more easily.

But in the brave new world of instant credit and rapid moving of money, instead of borrowing directly from savers, banks and other lenders borrow money from the capital markets, of which people like me putting money into CDs are a drop in the bucket. This means they can lend out a lot more than ordinary people in the US save (since most of this money comes from overseas or from the fabuously rich) for more profit. And, with the help of derivatives, they can actually lend out more than is available in the capital markets in terms of real cash. They can also make larger profits by borrowing for cheaper rates than they would have to pay savers, because central banks have been printing money (BOJ and the carry trade especially, but Greenspan and his "not on my watch" overreaction as well).

So, basically the system now runs on loaning out more money than exists for less than it should cost, and it is mostly in the form of ultra short term money. When the plug gets pulled, even banks that don't have excessive defaults are still dependent on non-existent cash flows.

I still think this is mostly a lot of hot air and that maybe BOE has the best way to do it: provide emergency cash flow to lenders who are not overexposed and let the aggressive game players eat dust. But ultimately, the whole model is a crock and comes down to the same old mythology that if you can move money around fast enough you can create more money than a zero sum game. All you can really do is win at a shell game, until someone gets fed up with being cheated and decides to lynch (borrowing fro Kent's preferences) the con man.
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