Ben Bernanke, August 16, 2007:



So I wouldn't say that a rate cut is completely off the table, but my own feeling is that we should try to resist a rate cut until it is really very clear from economic data and other information that it is needed. I'd really prefer to avoid giving any impression of a bailout or a put, if we can . Therefore, what I'm going to suggest today is to offer a statement updating our views of the economy that will give some signal about where we think things are going but to stop short today of changing rates.





A week later, things weren't any better. Financial institutions still didn't want to lend to each other except against the best collateral, and markets still didn't exist for subprime securities. Bernanke's dilemma was whether to 1) just expand emergency lending to the banks, or 2) cut interest rates too. But with the real economy humming despite the financial turmoil, Bernanke worried the latter would look too much like a bailout (or a "put" option) for Wall Street.





Bill Dudley, September 18, 2007:



At the same time, this balance sheet pressure and worries about counterparty risk have led to a significant rise in term borrowing rates . Banks that are sellers of funds have shifted to the overnight market to preserve their liquidity, and this shift has starved the term market of funds, pushing those rates higher .... Moreover, the increased reliance by banks on overnight funding increases rollover risk and may limit the willingness of banks to expand their balance sheets to accommodate the deleveraging of the nonbank financial sector.





This is one of the driest descriptions of financial armageddon you'll ever read. Let's translate it into English. Banks knew they were all sitting on top of toxic waste, but nobody knew who was sitting on the most of it -- so they wouldn't lend to each other, except at punitively high rates, for anything longer than a day. But relying on such overnight funding made the banks vulnerable to de facto bank runs, and that made vulnerability made them less likely to keep lending even as shadow banks cut back on lending. In other words, a credit crunch. And less credit just when borrowers most needed it meant more people would eventually go bust ... hurting mortgage bonds even more, and making banks pull back further. Loops don't get much more vicious.





Janet Yellen, December 11, 2007:





Although I don't foresee conditions in the banking sector getting as bleak as during the credit crunch of the early 1990s, the parallels to those events are striking