Another major Deal and a new pair of contestants this morning in the great game of Deal or No Deal.

First, the overnight deal…and it’s a massive one.  All the world’s Bankers have combined forces for a massive “liquidity bomb” on the world markets.

The Fed, which is adding $50 billion into its own banking system today, will spray dollars around the world via swap lines with other central banks. They can then auction them in their own markets. The ECB, Bank of England and Swiss National Bank allotted a total of $64 billion for one day today.

“The timing, so early in the trading day, shows both the severity of the strains in the interbank market and as well the authorities’ determination to resuscitate orderly functioning of the money markets,” said Julian Callow, head of European economics at Barclays Capital in London.

Under the new arrangements, the ECB doubled the limit of dollars it can get from the Fed to $110 billion and Switzerland’s central bank can offer $27 billion, an extra $15 billion. New swap facilities with the Bank of Japan, the Bank of England and the Bank of Canada amount to $60 billion, $40 billion and $10 billion, respectively. The arrangements are authorized until Jan. 30.

Up to $247 billion in liquidity is being injected into the world markets in order to try to free up the totally locked system.

The London Inter-Bank Overnight Rate (LIBOR) is what global banks charge for loaning each other cash on a daily basis.  That LIBOR number went through the roof yesterday because global banks simply don’t trust each other.

They don’t trust each other because nobody wants to be the next Lehman Bros. disaster.  Nobody wants to go under, and that mistrust was represented by a LIBOR of over five percent, which is the equivalent of highway robbery.

The injection of cash loosened up the LIBOR to under four percent, still brutally high but not as bad as yesterday.  European shares have muddled through to a dead cat bounce stage.

But that brings us to today’s contestants on Deal or No Deal, Washington Mutual and Morgan Stanley.  Both are looking for a Deal.  WaMu has lost 95% of its value and is on the brink, going from $40 a share to $2.  It’s auctioning itself off, but so far buyers don’t seem to be terribly interested.

At the same time Morgan Stanley is looking to also get a Deal while the dealmaking is good, looking to hook up with a bank like Wachovia.

It wasn’t too many years ago that some federal regulators fretted about the dangers of letting commercial banks merge with the big investment houses on Wall Street. But in the current financial crisis, those mergers might be the only thing that saves some of Wall Street’s most storied firms, such as Morgan Stanley (MS) and a troubled lender like Washington Mutual (WM).

With Lehman Brothers (LEH) now history, panicked Wall Street investors sold off shares in both Morgan Stanley and Goldman Sachs (GS), despite the fact that both firms reported relatively strong earnings in recent days. Morgan Stanley’s shares plunged 24% on Sept. 17, as investors worried the white-shoe firm would suffer the same liquidity crisis that felled Lehman and threatened Merrill Lynch (MER). Morgan Stanley executives rushed to condemn the short-sellers they said were driving the sell-off. In a memo to employees (BusinessWeek.com, 9/17/08), Morgan CEO John Mack expressed his view that the firm was “in the midst of a market controlled by fear and rumors, and short-sellers are driving our stock down.”

There’s one huge problem however.

WaMu is the country’s largest S&L.  If it does go under without a deal, it’ll be the largest consumer bank failure America has seen so far, and it will be the FDIC that has to cover deposits for WaMu customers…to the tune of billions.

Wachovia would have the same issue if they take over Morgan Stanley.  They would then be on the hook for Morgan Stanley’s losses…and that means the FDIC would be on the hook for Wachovia AND Morgan Stanley’s losses as well.  That’s going to be a lot for anti-trust regulators to swallow.

Because again, the FDIC is almost broke.

BE very, very careful. There are reports the US Federal Deposits Insurance Commission is running out of money. Chairman Sheila Blair has been forced to issue a statement. “US banks are overwhelmingly safe and sound and the Government fund used to cover insured deposits will be adequate to absorb any losses, even high losses,” she says.

But Brian Bethune, US economist at consulting company Global Insight, said: “Additional failures of large banks or savings and loans companies seem likely, and that could overwhelm the FDIC’s insurance fund.”

Christopher Whalen, senior vice-president and managing director of Institutional Risk Analytics, said: “We’ve got a … retail bank run forming in this country.”

On Monday, US Treasury Secretary Henry Paulson said the nation’s commercial banking system “is safe and sound”, and that “the American people can be very, very confident about their accounts in our banking system”.

FDIC officials say 98% of US banks still meet regulators’ standards for adequate capital.

Associated Press reported that the FDIC was down to $US45.2 billion ($A57 billion) – the lowest level since 2003.

Whalen then wrote that reports the FDIC was running out of cash had no basis.

His statement said: “It is essential that people realise the US Treasury will advance whatever cash is needed by FDIC to address bank failures and make good the deposit insurance guarantee. There is no issue regarding the bank insurance fund, but unfortunately most of the public do not understand this. The FDIC needs to make this clear in all of its public statements.”

IRA has been constantly in contact with the FDIC and other regulators and knows more about this situation, I would suggest, than the US Government.

The situation may not have been helped by a report from American Banker concerning the deal by Bank of America, the FDIC’s biggest customer, with 10% of the nation’s deposits, to take over Merrill Lynch saying “it is unclear how much that acquisition would increase B of A’s risk profile”

If the FDIC goes, then bank runs will send us into a depression, period.  It wasn’t the 1929 stock market crash that caused the Great Depression, but the bank runs that resulted from the bank failures in 1930-1931.

If the FDIC has to make good on billions, confidence in banks will plummet and lead to massive withdrawals, further crippling the system.  It won’t take much in the environment we’re in currently.  Cash on hand reserves for most banks are well below 1% of assets.  The rest is tied up in risky investments.

If even 1% of depositors take out their cash money on the same day, the bank has to turn people away.  This causes a bank run, and people will panic.

IndyMac bank went under because people started making withdrawals.  It didn’t need much.  Imagine that multiplied by hundreds, if not thousands of banks…and imagine the billions if not trillions it would take to cover those deposits.

Now remember the FDIC is down to $45 billion or so.  AIG took more than that to save…for one company.

What happens when the Full Faith And Credit Of The United States Of America backing up your bank deposits aren’t worth the paper it’s printed on?

What happens when Deal or No Deal runs out of money to play?  Everything the Fed has done up until now has failed.  If the FDIC is challenged and even 1% of America withdraws their funds, the bank runs will collapse the economy overnight.  Period.

Phil Gramm was partially right:  This is a “mental recession”.  Only America being blithely unaware of how precarious the financials really are is saving the country from a massive bank run.

Be prepared.

Cross-posted at ZVTS.