Column : Why aren’t things getting better?

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: can start trusting each other and the money market can sputter to life.

The Paulson plan which has obtained support from lawmakers in the US is explicit about the first element: the US government will buy something like $700 billion of housing-related securities. This is a step in the right direction. But the other two problems remain: financial firms are low on equity capital and don’t trust each other. We continue to live without a money market.

Last week, the crisis has taken a new and more dangerous turn. Once again, with the benefit of hindsight this appears obvious, but it was not anticipated. The logic is simple and brutal. If big banks cannot trust each other, why should depositors trust them? Runs on banks appeared imminent.

Bank runs are peculiar. If there is even a small chance that you might lose your money when a bank goes down, it is efficient to run to an ATM to withdraw your money. But once it is clear that the bank is not going to go down, nobody wants to withdraw money.

An incipient run on banks in Ireland was stopped by the government unconditionally guaranteeing all deposits of all banks there. This led to two major problems. Deposits of banks of other countries started fleeing to countries with generous guarantees, thus destabilising other banks, and tempting other countries to act similarly.

The second problem lies in small countries where the fiscal depth of the government is inadequate when compared with the size of banks. Switzerland, Iceland, Singapore, etc. are large financial systems housed in small countries. When they have banks which are too big to fail, those banks are often too big to save.

This, then, is a brief sense of where we are in the crisis, and why the market has reacted adversely despite approval for Paulson’s $700 billion plan. That plan is necessary but not sufficient.

One of the most promising elements of a policy response has come from the UK on Tuesday. This involves three elements: liquidity injection to compensate for the collapse of the money market, guarantees for medium financing of banks, and equity injections into eight banks. Key design features of this package, and the magnitudes of resources involved, appear to have improvements compared with the American efforts. If this leads to a revival of the money market in London, this would mark a major step forward in resolving the crisis.