It's a solvency crisis

Banking activity indicates the economy is mired in a solvency crisis, not a liquidity crisis, according to John M. Mason in a piece at Seeking Alpha. A solvency crisis, he argues, takes much longer to work through.

To me, this has been the evolving picture of the economy, both in the United States and in the world, for the past year. We had our liquidity crisis and then we moved into the solvency problems phase. The system is working things out in an orderly and controlled way.

Yet, the Federal Reserve (and the Treasury) has stayed with the interpretation that the problem continues to be a liquidity one. That is why all the innovative facilities were created by the Fed. That is why the Fed supports the mortgage-backed securities market and the federal agency market. Their “Fed speak” is couched in the terms of the “liquidity needs” of the system.

By now the public thinks the Fed operates like a squid: When danger approaches, it ejects liquidity, ends transparency, and escapes.