Liquidity vs. Solvency

TechDirt has a good piece on liquidity versus solvency as it pertains to the current financial crisis.

If you're like me, you may have a rudimentary idea of how the whole financial system works, but this article did a good job of illuminating some oft-overlooked points.

Basically, many of the banks have liquidity (cash), but are so afraid that the others they lend to are insolvent (unable to pay back loans) that they won't loan. That's why you may have heard more and more people talking about the (until recently) obscure "TED spread," which basically represents the difference between the interest rate at which banks are lending to each other (the LIBOR -- or London InterBank Offered Rate) and the interest rate on US treasuries. It's a quick measure to determine how secure banks feel about lending to each other vs. putting money in the proverbial mattress. In normal times, this is pretty small, because lending short term money out to other banks is considered pretty damn safe -- almost as safe as lending to the US government. So, it's usually well below 1%. Over the past few weeks, it's been sitting above 4%, on many days -- which basically means that banks are simply sitting on their cash because they don't trust other banks at all. This week, it finally started dropping, representing at least some easing of concern (though it's still pretty high).