This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."
So even though the Fed has flooded the credit markets with cash, spreads haven’t budged because banks don’t know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."
I could not have said it better myself. A few days ago I went to the AIG web site and looked up their financials. I was curious how they spun this mess. Their balance sheet does not show a problem but they have a separate presentation explaining that they were in a severe financial crisis. The MBA in me says the balance sheet should reflect the risks the company is facing. It did not reflect these risks for AIG and the balance sheets for other financial firms do not reflect the risks either. You just cannot trust any of them. Now that’s a problem that is going to take a long time to fix!