Financial markets – especially the equity markets – have somewhat recovered since the financial markets reached a point of near meltdown around the time of Bear Stearns collapse. But the strains in money markets and credit markets remain severe and show little sign of improvement.

In mid-March – at the peak of the crisis - the Fed did not just partially bail out the Bear Stearns shareholders who would have been totally wiped out in the case of a disorderly collapse of Bear Stearns; more importantly the Fed effectively bailed out JP Morgan that had – like Bear – and still has a massive exposure to the CDS market; it bailed out the creditors of Bear Stearns who would have suffered massive losses if the Fed had not outright bought $29 billion of toxic securities held by Bear; and it effectively bailed out Lehman, Merrill and a good chunk of the shadow financial system as the Bear Stearns bailout – together more importantly with the new TSLF and the PDCF facilities – ensured – for the first time since the Great Depression - that systemically important broker dealers would have access to the lender of last resort support of the Fed. Without these new facilities and the Bear bailout a generalized run on many institutions of the shadow banking system would have occurred.

While the extreme tail risk of a systemic financial meltdown – and we were in mid-March one epsilon away from such a generalized run on most of the shadow banking system – was avoided by the trifecta of the Bear Stearns bailout, and the creation of the TSLF and the PDCF facilities the stresses in the financial markets – liquidity and credit crunch - remain severe as even the FOMC had to admit in its latest statement.

Let us analyze in more detail in which ways this liquidity crunch remains severe and persistent…