Still chasing shadows?

Paul Krugman Blog - NYTimes.com:

This article on the continued troubles in credit markets was informative. ...Here’s how I think about what has happened these past 2+ years. I think in terms of a sort of flow chart, showing ways that savers can connect with borrowers:

Traditionally — i.e., before the 1980s — the public put its money in banks, and banks made loans to borrowers: thus the diagonal arrow from banks to borrowers represents traditional banking.

By 2007, however, much of this traditional channel had been supplanted by shadow banking: debt was securitized, and the securities sold to the public — the straight arrow across the bottom of the figure.

Then the crisis came. The public rushed for safety, which basically meant guaranteed deposits. One rough indicator is holdings of MZM — money of zero maturity — which is the sum of bank deposits and money-market deposits:

In effect, the public rushed back into the banks. But the banks weren’t willing to lend out these excess funds. Instead, they accumulated deposits at the Fed:

To prevent a complete collapse of credit, the Fed in effect recycled these deposits back into private credit via the TALF and other securities-purchase programs. So funds now flow all around the first figure, getting to the public via “Bernanke banking” (my term.)

Everyone agrees that this is a stopgap, and we want to get the Fed out of the business of private lending over time.