Investors who believe that markets work best when governments stay as far away as possible are likely grinding their teeth again. In response to widespread rumors that major European banks are finding dollar-denominated sources of liquidity dry up, most of the Western world's central banks have decided to step in and address the matter. While this will certainly move the markets in the short run, central banks do not have an indefinite supply of fingers to plug the seemingly endlessly leaky dyke that is the European financial system.

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The Latest Effort
With Greece still apparently on an express lane to default, and fears of knock-on effects in countries like Portugal and Italy, investors have started to approach many European banks (particularly French and German banks) from the viewpoint that much of their balance sheet is about to go up in smoke. Accordingly, there are fewer and fewer willing lending partners in the market and many banks have reportedly found it difficult to get the dollar-denominated financing that they need.

In order to stave off yet another liquidity crisis, multiple central banks have decided that they must "do something" again. Prior to Thursday's market open, the European Central Bank, the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank announced that they would cooperate in an effort to bring more U.S. dollar liquidity to the market. Starting relatively soon, these banks will provide three-month dollar-denominated loans to European banks. (The policies of these banks affect the currency market like nothing else. For more, see Get To Know The Major Central Banks.)

The Good
This is certainly momentary good news for investors holding shares in European banks. Although many major banks have rushed to assert that they have no need of such loans, the fact remains that the central banks wouldn't be doing this if it wasn't necessary. Moreover, banks like Santander (NYSE:STD), Barclays (NYSE:BCS) and UBS (NYSE:UBS) may not need the loans themselves, but the liquidity efforts may help prop up their counterparties and keep the system from seizing up again - a situation that certainly hurts the good banks.

This move is also broadly (if only temporarily) positive for the stock markets and proxies like the SPDR S&P 500 (NYSE:SPY) or PowerShares QQQ (Nasdaq:QQQ); the risk trade has gotten some momentary CPR and big investors can still look forward to taking advantage of cheap money to lever up trades.

This announcement could also be somewhat positive for major American exporters like Boeing (NYSE:BA), General Electric (NYSE:GE), Caterpillar (NYSE:CAT) and so on. Though many of these companies can arrange financing with customers and bypass the weakened European banks, the freezing up of liquidity markets and additional bank collapses would do favors to the already rickety state of many European economies.

The Bad ... and the Ugly
At least in the short run, this move will probably be bad for U.S. bond investors and trading vehicles like the iShares 7-10 Treasury Bond Fund (NYSE:IEF) or the iShares 10 - 20 Treasury Bond Fund (NYSE:TLH). Despite the state of the U.S. economy and its debt situation, U.S. government securities still get the benefit of the doubt as a risk haven and the central banks' decision to prop up the risk trade will draw money away.

Longer term, this decision could simply make a bad situation worse. SPDR Gold Shares (NYSE:GLD) have sold off in the wake of this announcement as it looks like the fear trade is going to have to wait a bit to see another big bank collapse or a sovereign default. Still, it is hard to dismiss the idea that this is a "pay now or pay later" type of situation and forestalling the day of reckoning for banks with too much bad sovereign debt is likely to only make the eventual clean-up more expensive and traumatic. (For related reading, see How Countries Deal With Debt.)

The Bottom Line
There are certainly those who believe the governments of the world need to step aside, let banks (or countries) fail and let the markets clear. On the other side are those who argue that the situation is bad, but disorderly failure and panic is even worse and will drag down the healthy as well as the sick. Perhaps the middle position is that this new central bank liquidity facility is something like methadone - it's not at all a good thing to need methadone therapy, but if the alternative is worse it may serve a role.

In the meantime, investors should beware of the false dawn. European banks still have a lot of problems; even those with balance sheets free of PIIGS paper have to contend with dismal operating conditions and the possibility of the disorderly failure of one or more competitors (and counterparties). There are values to be had out there, but the risk may be higher than the markets would seem to suggest. (For more on the balance sheet, see Reading The Balance Sheet.)

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Tickers in this Article: STD, BCS, UBS, SPY, IEF, GLD, GE

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