liquidity, and the quality of loans continues to deteriorate because of the adverse feedback loop between the financial system and the real economy. a “ mirage ” phenomenon is taking place in that, despite public capital injection, concern over additional losses on the assets mounts over time and such concern in turn will heighten concern for a capital shortage of financial institutions. under those circumstances, it is of vital importance to remove uncertainty. there are two options to remove uncertainty stemming from financial institutions ’ nonperforming assets ; the government purchases those assets or provides a loss guarantee to those assets. nevertheless, even in both cases, uncertainty might not be removed for the assets not covered by the purchases or the guarantees, and investors thus would continue to ask the institutions for high risk premiums. consequently, the institutions might not be able to fully restore confidence in the market. in addition, there are also other difficulties ; how to set the selling price of the nonperforming assets in the case of asset purchase scheme and how to set the fee in the case of guarantee scheme. what japan faced in the past and what the u. s. is facing now is arguably those difficulties. however, even with such difficulties, it is an indispensable process to promptly identify the amount of losses and to carry out recapitalization to secure financial system stability, if necessary. it should be noted that new issues have emerged in the global financial system as public capital injection prevails. one of them is a gap between the level of capital recorded on the balance sheet and market participants ’ perception of franchise value of financial institutions. the level of capital presumably should reflect market expectations about earning growth potential of a firm. on one hand, recapitalization by the government serves as a buffer for future losses, in the same way with privately raised capital. on the other hand, it comes from different incentives from private capital, in which investors shoulder the risk with an expectation to recoup their investments by the future growth of the firm. in addition, if people increasingly tend to judge the soundness of a financial institution simply by looking at the level of capital on the balance sheet – in other words, looking at the capacity to absorb future losses rather than the earning growth potential –, a financial institution could face a paradoxical situation. a financial institution which does not accept public capital because of its financial soundness might suffer a competitive disadvantage against another institution which accepts public capital, because the sound institution has a lower capital

market operations and the discount window, strains in term funding markets persisted and became particularly elevated in early december in response to year - end pressures. the magnitude of these strains can be gauged using the spread between libor – that is, the london interbank offered rate – and the overnight indexed swap ( ois ) rate at the same maturity, because the ois rate reflects the average overnight interbank rate expected over that maturity but is not subject to pressures associated with credit and liquidity risks to the same degree as libor. as shown in chart 2, the one - month and three - month libor - ois spreads were at low levels through the month of july but increased markedly in august and early september at the onset of the financial market turmoil. 6 the one - month spread declined during the fall but rose sharply again toward the end of the year. in association with these wider spreads, liquidity in term bank funding markets deteriorated substantially. to address these pressures, the federal reserve introduced a new policy tool called the term auction facility ( taf ). 7 with this tool, the federal reserve auctions a pre - announced quantity of credit to eligible borrowers for a term substantially longer than overnight ; thus far, each auction has involved a term of one month. as with primary credit, a depository institution is eligible to participate in a taf auction if the bank is judged to be in generally similar patterns are evident in the spread between the term federal funds rate and the ois rate at these maturities. the taf was introduced as a temporary measure, but the federal reserve has left open the possibility that this facility could become permanent ( bernanke, 2008 ). sound financial condition, and a wide variety of collateral can be used to secure the loan. the minimum bid rate for each auction is established at the ois rate corresponding to the maturity of the credit being auctioned. the introduction of the taf was announced on december 12 in conjunction with related announcements by the bank of canada, the bank of england, the european central bank, and the swiss national bank ( board of governors, 2007c ). 8 the first two auctions were held on december 17 and 20, for amounts of $ 20 billion each, and were very well subscribed : a large number of banks participated in each auction, and the total value of bids was about three times as large as the amount of credit auctioned. the resulting interest rate in both cases was about 50 basis points above