Lehman Brothers Some weeks ago, I published an appeal for a comprehensive policy solution that spanned the core problems in the financial sector (ie, lack of liquidity in markets, doubts about the value of troubled assets and a clear shortage of capital) and spanned financial markets around the world (ie, not just a few money centres). Although a great many policy actions have since been taken, they have been neither comprehensive nor global. Indeed, the approaches taken have been so varied and inconsistent, especially with regard to deposit guarantees, that they are intensifying problems for other countries. It should come as no surprise then that market confidence has not been restored.
What is the underlying problem? In a nutshell, financial institutions are holding a large volume of securities of falling and doubtful value, and which imply large losses for them. There are also potentially further losses from having insured asset values through credit default swaps and other derivative instruments traded in not-so-transparent over-the-counter markets. But even if a bank knows that its own balance sheet is intact, it cannot be sure that its counterparty is in the clear (or in some way exposed to a third party with problems). In this febrile environment of distrust and capital shortage, standard macroeconomic policy instruments are blunted and a strategy that relies mainly on liquidity provision by central banks – while essential – will not suffice.
