Why?!

Stock markets are collapsing in general, bank shares are dropping even fastest. Banks are seemingly unwilling to lend to each other. Why? It all seems to have coincided quite nicely with the downgrade of Americas sovereign debt. But the likelihood of an American default is not the reason for all this. If it was investors would be unwilling to lend to the US government, instead they are falling over each other trying to get America to take their money, yields on treasury bonds are at record lows. Taking expected inflation in to account investors are actually paying for the privilege of lending money to the US government.

Why are investors desperate to lend the American government? It's for the same reason the stock market is dropping like a stone. Unexpectedly low growth in America and Europe. The economy isn't growing on its own since everyone is still buried in debt since the financial crisis and are still paying it off. In Europe spending cuts and tax increases are doing a better job then expected at killing growth. In America a newfound fixation on the debt is making any plan to spend more politically impossible. Here if anything the S&P downgrade played a part, by making any government stimulus even less likely. When it comes to monetary policy the Federal Reserve has already tried its old tricks and some new to breath new life in the the economy so more action and the effectiveness of such is questioned. On the other side of the atlantic the ECB is focused on buying up Spanish and Italian debt to keep those economies from being crushed by interest rates they can not afford to pay. So the economy is stagnating and there does not appear to be anything governments can or at least are willing to do to help. So markets are realizing that the companies they have invested in aren't going to do as well as they had expected, driving down their value making the alternative in the form of government bonds look much more attractive.

Investors are especially keen on getting rid of bank shares since banks are perceived to be especially vulnerable as the economy slows. This is partly because some of them own a large amount of government bonds of risky origin like Greek and Portuguese bonds. But also that the value of their assets in general will fall as the economy slows potentially giving them liquidity problems.

So to sum it all up, it is all to do with lower then expected economic growth.