the problem has spread

in the short term, it is no longer a mortgage securities problem.

i was surprised by how many european banks needed help. it turns out that this is because in terms of loan/deposit ratio, european banks actually lend an average of 1.4 € to the €, compared to 96 cents to $1 of deposits for US main street banks (that is why US regional bank share prices are still holding fairly steady).

banks have been used to liquidity provided by short term money market funds and institutional investors which issue 3, 6 and 9 month paper. in effect there is a run on this shadow banking system, and so banks have to borrow overnight from one another. this leads to a bidding up of overnight rates to crazy levels of 6.88%, and 11% to borrow dollars from the ECB (The Economist). Banks seem to want to hoard cash even though they can earn more lending to each other. So this will affect your run of the mill lending rates which affect the economy.

there are arguments that the paulson plan will not solve the crisis, because if the crisis is in the money markets now, then the problem is no longer the value of MBS. to fund the plan, they need to sell T-bills, but in the current climate, people prefer to hoard cash and pile into T-bills. So there is no net credit creation and still a drying up of credit lines to private businesses, and this represents a liquidity trap. (naked capitalism) In simple terms, this is a crowding out. Given uncertainty, I would rather lend to the government than to private firms/banks, as T-bills are less risky. This will drive yield down on these things, but if the fed keeps issuing, the yield will not fall as fast, so it still makes sense given the risk environment to just keep your money in them.

the view that a recapitalization of the banking system is what is truly needed now appears to be a consensus view among economists.

regarding the strength of the euro, marginal revolution puts forth the argument that the chinese now trust the us$ as a "battle-tested" currency, as the us has never tried to wipe out the chinese. he also mentions that european banks are now facing bigger problems and their problems will be a larger share of european gdp.

capital needs to flow back into the system. i think this needs a global solution, given that there is a global imbalance in capital concentration and capital flows which is not making this any easier.

i guess i'll be taking international economics. one of the lecturers is just back from a stint at the new york fed, so i hope to be hearing more about this soon.