The TED Spread and the Flight to Liquidity

Paul Krugman tries today to explain why he's so obsessed by the spread between Treasuries and Libor:

I got to ask Fed officials about [it], and was told that they preferred the OIS spread, based on Fed funds futures prices. They didn't like the Ted spread, they said, because they thought liquidity issues distorted Treasury rates.
But I gradually became convinced that those liquidity issues were actually at the heart of the story. Basically, even Fed funds suffers from fear of bank defaults: it's an unsecured loan, just like LIBOR. So the comparison between 3-month Treasuries and LIBOR is telling you how much of an interest rate loss investors are willing to accept in return for something that's really, truly safe.

Well, yes, up to a point. But "liquidity issues" includes a hell of a lot more than just credit risk, otherwise there wouldn't be any spread between on-the-run and off-the-run Treasuries. (Which spread, as I recall, was in large part responsible for the implosion of LTCM.) Indeed, it might be interesting to look at the TED spread in light of what's happened to the spread between on-the-run and off-the-run Treasury bonds, using the latter as a proxy for the flight-to-liquidity (as opposed to flight-to-no-credit-risk) trade.

Meanwhile, John Jansen has a more optimistic take on three-month Libor widening out:

A second factor to consider is the developing notion that the FOMC is nearly finished with this ease cycle. Against that backgound, the money market curve should steepen and it has... I am hearing that one month Libor will set about 5 ?? basis points higher tomorrrow and 3-month libor is indicated 6 basis points higher.

One imagines that if the money market curve is steepening then the Treasury curve should be steepening too, with no net effect on the TED spread. But there's so much weirdness going on in the markets right now that one shouldn't take anything for granted.