The new challenge for the world's central bankers is not saving another bank or financial institution. It's restoring confidence in world markets.

Just like August 2007 when the US housing debacle began, investors and bankers are now distrustful of lending money even to fellow bankers. When giant insurance company AIG needed help, no one except the Federal Reserve was willing to come to the rescue. The US stock market, sometimes considered a barometer of confidence in the economy, is slipping further into the red. Overseas, market losses are steeper.

"While there is a crisis in credit, there is an even greater crisis in confidence," says Sam Stovall, chief investment strategist at Standard & Poor's in New York.

The short-term implications of the void in confidence is skyrocketing short-term interest rates, which have prompted central banks to inject billions of dollars to try to calm world markets. Longer term, unless confidence returns, the world's economic prospects could dim further.

"Clearly we are in a recession, but this drives us into a deeper and broader recession throughout the world," says Sung Won Sohn, an economist at California State University, Channel Islands.

In the US, the financial events of the past few weeks hit a dizzying pace. On Sept. 7, the US government took over Fannie Mae and Freddie Mac, both major players in the mortgage market. Then on Monday, Lehman Brothers filed for bankruptcy after the government refused to bail it out and Merrill Lynch was purchased by Bank of America. On Tuesday night, the US Federal Reserve agreed to give insurer AIG a short-term bridge loan of $85 billion so it can begin to sell some of its assets. At the same time, there were reports that regulators are gauging interest among other banks in buying Washington Mutual.

Globally, there are reports of major changes as well. In London, Britain's largest mortgage lender, HBOS, saw its stock lose 30 percent of its value in two days and there are reports it will be acquired by Lloyds TSB.

The authorities in London have already stepped in on one occasion to save a failing bank, Northern Rock. Britain acted after depositors lined up around the block to get their money, the first run on a British bank in 150 years. The government finally decided it would have to effectively nationalize Northern Rock, at a cost of around $100 billion to the taxpayer. Chancellor Alistair Darling explained the British rationale on BBC Radio this week: "The test that we apply, and the test that I think the Americans apply, in relation to any institution, is if it went down, would there be a systemic risk – in other words, would it have a knock-on effect into the rest of the system."

The massive financial changes are prompting investors to shift to US Treasury securities, considered ultrasafe. However, this has also left many banks and financial institutions struggling to raise short-term cash.

In Portland, Ore., John Lekas, portfolio manager of Leader Short-Term Bond Fund, says he has been buying depressed bonds from regional financial institutions and getting returns of 13 percent to 21 percent. "No question, we've got a panic going on right now," says Mr. Lekas. "It's actually worse than last August."

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