The WSJ says this evening that credit markets are seizing up again. They base their argument largely on increases in Libor rates as well as a widening of spreads for corporate debt.

Short-term credit markets are still performing better than they did last year thanks to government programs to buy commercial paper and guarantee short-term debt. But Libor, the London interbank offered rate, a common benchmark interest rate, has crept up over the past weeks, from 1.1% in mid-January to 1.3% on Friday, reflecting banks’ concerns about being paid back for even short-term loans. It is still well below its peak of 4.8% last October.

This time around, the economy is slipping deeper into a recession, and bond investors worry the government’s repeated modifications to its financial-rescue packages are undermining the very foundations of bond investing: the right of creditors to claim their assets first if a borrower defaults. Without this assurance, bonds of even the most stalwart institutions are much riskier to own.

After what seemed like the beginning of a thawing of debt markets early in the year, sentiment has deteriorated, analysts say. The markets remain open only to the strongest companies. A rally in U.S. Treasury bonds last week reflects another bout of flight-to-quality buying. Junk bonds now yield 19 percentage points more than safe Treasury bonds, up from a 16-point spread in February, according to Merrill Lynch. The spread is still narrower than the 21-percentage-point premium reached last December, but any widening shows investors are becoming more fearful.

The article, which you should read in its entirety, attributes much of the deterioration in market sentiment to a lack of clarity over government policies. Specifically, they allege concern as to how the government is going to treat debt holders in the event of cataclysmic events like a GM bankruptcy or a nationalization of major banks.

There are two issues here as I see it.

First, the private sector is now held hostage to the next plan to come out of the Treasury Department. No clarity exists as to what plan will be announced on Monday and altered on Friday. Effectively, no business plan has been offered that says here is how we want to get from point A to point B, here is how we plan to accomplish this and we are committed to executing this plan.

Second and not unrelated to the first is that the credit markets right now art an artifice. Essentially, the fundamentals are a creation of the Fed and to a smaller extent central banks elsewhere. The information flow means little or nothing since risk taking, if you can call it that, is relegated to whatever the Fed happens to support at the moment. Until the oxygen is withdrawn speculation about the relative health of the markets is nothing more than that — speculation.

As much as the political class may enjoy the enormous power they currently enjoy, it is incumbent on them to realize that an economy cannot function in this manner. Washington can be the political capital of the country but it can’t be the economy capital as well. They have to quickly give back the economic sway that has accrued to them by dint of crisis or they risk destroying the financial system.