Nearly two weeks ago, it was becomimg apparent that central bank liquidity operations were not merely ineffective, but had become counterproductive in getting banks to lend to each other. As FT Althaville noted:

Liquidity is being thrown at the system, but it’s just making things worse. By pumping in more money central banks aren’t addressing the fundamental concerns of the banks at all. Going cold turkey is a very unpleasant thing, but the solution isn’t more drugs, even if they alleviate short term pain. In assuming they can rely on central bank money market operations – which will be expanded (as is the case) when the going gets tough – banks are naturally avoiding lending to each other.

True to recent form, three month dollar Libor rose today and measures of stress in the money markets hit new highs. Reluctance to lend is not surprising, particularly since the determination of settlement prices of over $400 billion of Lehman credit default swaps is today, a big source of anxiety. From Bloomberg:

The cost of borrowing in dollars in London for three months rose as cash injections and interest-rate cuts by 10 major central banks failed to thaw a credit freeze that put stocks on course for their worst week in 30 years. The London interbank offered rate, or Libor, that banks charge each other for such loans climbed 7 basis points to 4.82 percent today, the British Bankers’ Association said. The rate in Tokyo jumped to the highest since 1998 even as the Bank of Japan added more than $30 billion to the banking system. The overnight dollar rate tumbled 262 basis points to 2.47 percent…. “Central banks are trying to supply liquidity, and in many cases it just comes back to them,” said Robin Marshall, director of international fixed income in London at NCL Smith & Williamson, which oversees about $20 billion in assets. “There’s a real problem in getting people to put their money to work. The fear of counterparty risk is so intense that the only bank prepared to lend at the moment is the central bank”…. Banks in South Korea stopped giving credit to importers….. The Bank of Japan added 3 trillion yen ($30.3 billion) to the banking system and the Reserve Bank of Australia pumped in A$2.63 billion ($1.8 billion). The European Central Bank today loaned banks $94 billion for four days… The Libor-OIS spread, a gauge of cash scarcity, climbed to a record 366 basis points….The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was at 422 basis points. It widened to 423 basis points yesterday, the most since Bloomberg began tracking the data in 1984. “While the authorities across the globe have taken a host of unprecedented measures to shore up confidence, nothing seems to be working,” Rajiv Setia and Piyush Goyal, strategists at Barclays Capital Inc. in New York, wrote in a report. “Participants are increasingly unwilling to bear counterparty risk with any entity, other than the government, at any price.”

Bond market commentator John Jansen worries this morning that Treasury prices are not behaving as expected, and may be a sign of a turn in sentiment against the dollar: