To put this patient to bed so to speak, for banks the issue is not one of reserves, but one of capital. Reserves are what the regulator says you must hold based on formulas involving the size and nature of deposits you are holding. Capital is what you have to work with, the base from which you make loans and do business.
Liquidity relief from the Fed can help avoid a credit crunch, which is a short term liquidity problem that can come from a variety of sources, including operational problems like major snowstorms impeding check clearing, major events such as 911, and bank panics. The key phrase is short term imbalance between supply and demand.
``There is no relationship between non-borrowed reserves and anything the Fed cares about, be it inflation, employment or real GDP,'' said Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago.Insolvency is the real financial problem here. Insolvency stems from insufficient working capital to meet the continuing business needs of the bank, not incidentally, but because of some major business loss depleting capital or a failure to make the appropriate growth provisions. Its working capital that banks are seeking to increase when they sell preferred shares to the SWFs, for example.
Capital is something the Fed cannot directly provide. It does not buy bank shares. It can help to arrange mergers and rescues. It can make capital sufficiently inexpensive to make deals between parties feasible. But it cannot (at this time) directly intervene in the corporate bond and equity markets. The Fed and Treasury did surprise us after the tech bubble bust, so let's continue working on our differential diagnosis , because the financial system still seems to be suffering from a sickness unto death.
Here are a few charts worth watching and perhaps becoming concerned about at some point although by the time it shows up here...
