"...traded derivatives indices, such as the ABX index for sub-prime securities, point either to very severe outcomes for credit losses or, more plausibly, embody large discounts for illiquidity and uncertainty. For example, at face value, ABX prices imply... a probability of default of 76% and a loss given default rate of 50%, both of which would be unprecedented... prices of AAA tranches of the ABX index appear to be particularly out of line with credit fundamentals... credit losses from the turmoil are unlikely to ever rise to levels implied by current market prices unless there is a significant deterioration in fundamentals, well beyond the slowdown currently anticipated. That is because prices are likely to reflect substantial discounts for illiquidity and
uncertainty that have emerged as markets have adjusted but which should ease over time."

The FT comments: "The Bank of England’s insistence that assets are fundamentally mispriced will raise the question again of whether authorities should step in to buy up mortgage-backed securities themselves. The bank says that if investors do not reappraise risks and start buying again, there is a moderate risk of a much sharper slowdown." (See also Lex).

The Fed is considerably less sanguine - see this report of a possible expansion to its term auction facility.