What Bankers Fear

Make no mistake: The central bankers' announcement Wednesday of a new coordinated effort to pump cash into the global financial system is a sign of their nervousness. The global credit squeeze that began last summer still hasn't run its course, and the central bankers fear that the stressed financial system could pull the world economy into a deep recession.

Thus the bankers' decision to shower the system with money, through a new system of auctions that will allow banks to borrow more cheaply than they can through the commercial interbank market. What's unusual is that five leading central banks agreed to act as a joint rescue committee.

The aim isn't so much to prevent a downturn -- the bankers aren't sure that's possible, or even desirable -- as to mitigate its effects. Fed officials have decided that they need to let the adjustment happen in financial markets, with prices of mortgage-backed securities and other assets falling to levels that will allow the markets to clear.

What scares the central bankers now is the evaporation of trust from the system. Banks don't believe each other's numbers; since nobody knows the real value of some of the mortgage-backed securities everyone is holding, they assume the worst. They start hoarding cash as a buffer against their own losses and because they're nervous about lending to anyone else.

"The basic problem is that banks don't trust each other. They can't get financing, so they don't lend, and this can cause spillover into the larger economy," explains Ted Truman, a senior fellow at the Peterson Institute in Washington and the Fed's former top international economist.

"If someone would take me out of all my positions, long and short, I'd do it," he said. This is the financial market equivalent of saying you want to start over. Six months into the credit crunch, that's the way many exhausted players are feeling. The markets will have to sink a good deal more, alas, before the vultures arrive to carry off the debris and the process of rebuilding can start.