Once again, the ever-incisive Financial Times columnist Martin Wolf, an economist, identifies with laser-accuracy what ills the current market. The problem, Wolf argues, is not a lack of solvency but a lack of liquidity (i.e. 'panic').

Wolf does not deny that there have been bad loans (there have been) or that no companies will go out of business (some will). But the circumstance that froze credit markets, that caused quality corporate bonds to fail to price, and that leads to 100-point spreads between the LIBOR rate (what banks charge each other) and the ECB's benchmark interest rate, is rooted more in a lack of confidence, than a lack of sound economic fundamentals or a lack of resources.

A lack of liquidity

And a lack of liquidity or 'panic' is something that central bankers can address. With the above in mind, the U.S. Federal Reserve's plan, in consultation with the European Central Bank, the Bank of England, the Swiss National Bank, and the Bank of Canada, to inject $40 billion via auctions into the financial system is appropriate and prudent. (Further, in addition to reciprocal currency arrangements, the companion central banks will take related actions, including the Bank of England's decision to accept a wider range of collateral on 3-month loans).

Will this be the last intervention by The Fed and the other major central banks? Most likely, no.

Will the intervention work? Like Wolf, other economists, including David H. Wang, believe it will, provided the problem primarily is a lack of liquidity, and not a lack of solvency.

Several consequences

However, this is not to say that there won't be intended and unintended consequences from the central banks' action. There will be several, and two are described here.

First, there will be the rescue of some incompetent bankers and mortgage lenders. Or, more theoretically, there is a chance that the principle of moral hazard will be violated. Briefly, that theory argues that poorly-run businesses that made wrong choices should be allowed to go bankrupt, and that rescuing them would encourage more bad choices, or violate the moral hazard guiding businesses to make the right choices and earn a profit.

Second, there will be the mighty hand of the U.S. Congress. There's a Washington, D.C. adage that goes, "Congress doesn't act, unless not acting will bear the wrath of the American voter." That roughly translates to, "Congress is otherwise occupied... unless there's something to attract its attention." And in-touch voters will attract the Congress' attention. And that can only lead to tighter and more-effective regulations.