The Federal Reserve injected $480 billion domestically and globally last week and it doubled the dose this Monday, injecting more than $900 billion in one single day. That makes for almost twice the $700 billion rescue package that Congress approved with so much discussion last week.

Yet banks are still refusing to lend to each other, and when they do lend they charge a record-high risk premium -- which more than cancels out any Fed rate reductions. At the same time, banks have absorbed about $1.5 trillion in cash from the Fed, more than twice the most likely loss in the mortgage markets (about $600 billion). It now seems that they will absorb as much cash as the Fed decides to throw at them.

What we are witnessing is what economists call a rise in the liquidity preference, which was the main factor leading to the Great Depression. By a rise in the liquidity preference we mean that investors aim to increase the share of liquid instruments in their total assets. For the banks it means they want to liquidate loans and transfer the proceeds to very liquid instruments, such as Treasury Bills.

This migration depresses the economy by reducing credit. In these circumstances, the solution is not to keep on throwing money at the banks, which are inclined to hoard it not lend it. Rather, what is needed is stopping the skyrocketing increase in their liquidity preference and then lowering it. Doing that requires writing off the losses now lodged in the financial system as soon as possible.

A simple analogy will help illustrate this point. Imagine that you are playing poker with 10 people and that you learn that a minority of them is broke and would not pay you if they lose. You don't know, however, who the ones are who won't pay. In this environment, the risk of losing would be too high even if you know that most of the players are perfectly sound financially and would pay up if they lose.