Central banks are acting as "buyers of last resort" rather than "lenders of last resort". They are providing cheap (negative real interest rate) term funding. The loans will have to be rolled over, as the banks cannot repay them. They will only be repaid from the underlying cash flows of the assets lodged as collateral.

Government and central banks have also "bailed out" a number of financial institutions using a variety of strategies to limit contagion. Lower interest rates and increased government spending has been used to try to reduce the effects of the financial crisis on economic activity.

The US government’s $700 billion package is the latest magic potion. It is puzzling why this initiative is seen as the "silver bullet" that will "fix" the problems.

A cursory analysis of TARP (Troubled Asset Relief Program) reveals considerable confusion about even what problem it is addressing. The proposal to purchase up to $700 billion in "troubled" assets is not dissimilar to the existing liquidity support provisions in place. If assets are correctly valued in the books of the selling banks, then purchase at that fair value only provides funding to the bank. The difference is the risk of the securities is transferred to the government but so is any possible recovery in the price.

There are different views as to what price should be paid by the government for these assets. Under one approach, the government would pay a "hold-to-maturity" price that may be (perhaps significantly) higher than the "market" price or the value in the bank’s book. This would provide the bank with liquidity as well as capital (the gain between the price paid and the lower value to which the bank has written down the asset). The alternative approach would be to pay "market" values. This would provide liquidity to the selling banks but no capital. It may even trigger additional losses where the assets are carried at higher values, creating incentives against participation. There is also the problem that nobody, even the super bankers with super computers, seems to have a clear idea what the securities are worth, in any case.

Purchases of troubled assets are also conditional on (correctly) protecting the taxpayers against losses. This requires banks to provide the government with equity or equity-like interests in exchange for participating in the program. Alternatively, the institutions selling the assets will need to enter into contingent arrangements to minimise the risk of loss to the taxpayer. Commentators have gone into rhapsodies about the ability of the taxpayer to "profit" from the program. This creates potential conflicts for financial institutions whose fiduciary duties require maximisation of returns for shareholders.

It is not clear what securities will be eligible for purchase and exactly who will be allowed to participate. Amusingly, the recent short selling ban on financial institution stocks saw a curious array of companies claim that they were financial institutions! Gaming of the system will be practically difficult to control.

In fairness, the final form of TARP has not been settled and may provide greater clarity on these points.

TARP and many of the other initiatives merely transfer the problem onto the US government and taxpayer balance sheet.

Government support for financial institutions in this financial crisis is already approaching 6% of GDP (compared to less than 4% for the Savings and Loans crisis). This will ultimately place increasing pressure on the US sovereign debt rating and vitally the ability of US to finance its requirements from foreign creditors.

Government and central bank initiatives to date have been ineffective. Money markets remain dysfunctional and inter-bank lending rates have reached record levels relative to government rates. The failures are unsurprising.

At the height of the boom, banks used a variety of techniques to increase the velocity of money. As the system deleverages, the velocity of money has sharply decreased.