December 13, 2007
My son Max turns 13 today which makes this a very happy occasion. But regrettably the global economy continues to be plagued by a wave of pessimism and disorder in financial markets.
The US Federal Reserve has announced a series of special loan auctions with the goal of injecting much needed liquidity into the world banking system. Just yesterday the Union Swiss Banking corporation announced a writedown of 10 billion US dollars because of money market sour investments conected to the non bank commercial asset crisis. The Fed in consultation with the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National bank has decided to launch these auctions with a wide range of collateral being acceptable in order to restore some much needed confidence in global financial
markets.The Federal Reserve press release is reproduced below. The fact that the Fed and other central banks have acted is a good thing and it confirms that the crisis brought on by the bad debts associated with the asset backed non bank commercial paper crisis is a very serious threat to financial stability . We may well have reached a turning point in the general policy environment with respect to regulation, market intervention and the relevance of Keynesian management of monetary and fiscal policy.
So far the measures announced have faiuled to lower inter bank loan interest rates because there is still widespread lack of confidence in the money markets about the full impact of the crisis. According to Bloomberg business news reporter Gavin Finch in London recent European estimates of the full extent of the writedown may reach 400 billion dollars. I reproduce excerpts from Finch's article below.
Dec. 13 (Bloomberg) -- The interest rates banks charge each other for short-term loans in Europe failed to decline from the highest levels in seven years a day after central banks joined forces to break a logjam in money markets.
The cost to borrow for three months remained at 4.95 percent, the British Bankers' Association said today. That's 95 basis points, or 0.95 percentage point, more than the European Central Bank's benchmark interest rate, compared with 57 basis points a month ago. The difference averaged 25 basis points in the first half of the year, before losses on securities linked to U.S. subprime mortgages contaminated credit markets.
The highest short-term rates since December 2000 suggest that the first coordinated central bank action since the Sept. 11, 2001, terrorist attacks may not be enough to revive interbank lending. The cost of borrowing dollars fell 7 basis points to 4.99 percent, about half what was anticipated, based on prices of Libor futures contracts.
``It's not going to help us find an exit to this crisis,'' said Cyril Beuzit, head of interest-rate strategy at BNP Paribas SA in London. ``These measures aren't going to address the root cause of the crisis. Banks are still reluctant to lend money to each other because there are serious concerns about potential further bad news.''
....
The (central bank )measures won't succeed in bringing down borrowing rates until next year, futures trading in Europe suggests.
Implied yields on Euribor futures contracts expiring this month through June 2009 rose today, with the December contract climbing 6 basis points to 4.92 percent. The implied yield on the March 2008 contract gained 6 basis points to 4.6 percent.
``The markets don't expect spreads to go down,'' said Alexander Titsch-Rivero, head of derivatives and structured products in Frankfurt at BHF-Bank AG, a German private bank. ``The actions by the central banks were just a placebo, a tranquilizer that doesn't solve the problem of the mistrust among banks on one hand and the potential for more losses in credit on the other.''
....
``It's a very disturbing sign,'' said Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt. ``I'm alarmed by the impact this is having, which underscores that the funding difficulties out there are enormous.''
The Fed plans four auctions, including two this month that will add as much as $40 billion, to increase cash in the U.S. The Bank of England said it would widen the range of collateral it will accept on three-month loans.
Seized Up
Short-term credit markets seized up in August, raising concern that the lack of capital flow between banks will hurt the economy. Goldman Sachs Group Inc. in a report a month ago estimated losses related to record home foreclosures may be as high as $400 billion for financial companies. If accurate, banks, brokerages and hedge funds would need to cut lending by $2 trillion, triggering a ``substantial recession,'' the firm said.
Borrowing costs have soared over the past four weeks as banks sought loans that will cover their commitments through to the start of next year.
``We're coming up to a real end of the year liquidity squeeze,'' said Stewart Taylor, who trades Treasuries in Boston at Eaton Vance Management, which oversees about $4 billion of taxable bonds. ``A lot of people are just pumping into bills rather than lending. Why loan money over the end of the year if you don't have to.''.....
U.K. Prime Minister Gordon Brown said the surge in credit costs should spur increased transparency in the banking industry and change the way credit-rating companies work.
``It's a wake-up call for the global economy,'' Brown told lawmakers in Parliament in London today. ``The existing institutions aren't good enough.''
Fed Bank of New York President Timothy Geithner said today central bankers are looking at ``additional instruments'' to provide funds to banks in times of stress.
``The market is underestimating the significance of the move by the central banks,'' said Ciaran O'Hagan, head of interest-rate research in Paris at Societe Generale SA. ``It's a strong action that will tide us safely over year-end and hopefully restore confidence to the money markets early in the new year.''
Turmoil in the credit markets has caused losses for everyone from shareholders of New York-based Citigroup Inc., the largest U.S. bank, to Florida schools and towns invested in a state-run fund that owned downgraded and defaulted securities issued by SIVs. Citigroup, which said its mortgage-related writedowns may reach $11 billion this quarter, has fallen 39 percent since June on the New York Stock Exchange.
To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net
US Federal Reserve Press Release
Release Date: December 12, 2007
For immediate release
Today, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing measures designed to address elevated pressures in short-term funding markets.
Federal Reserve Actions
Actions taken by the Federal Reserve include the establishment of a temporary Term Auction Facility (approved by the Board of Governors of the Federal Reserve System) and the establishment of foreign exchange swap lines with the European Central Bank and the Swiss National Bank (approved by the Federal Open Market Committee).
Under the Term Auction Facility (TAF) program, the Federal Reserve will auction term funds to depository institutions against the wide variety of collateral that can be used to secure loans at the discount window. All depository institutions that are judged to be in generally sound financial condition by their local Reserve Bank and that are eligible to borrow under the primary credit discount window program will be eligible to participate in TAF auctions. All advances must be fully collateralized. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.
Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). The first TAF auction of $20 billion is scheduled for Monday, December 17, with settlement on Thursday, December 20; this auction will provide 28-day term funds, maturing Thursday, January 17, 2008. The second auction of up to $20 billion is scheduled for Thursday, December 20, with settlement on Thursday, December 27; this auction will provide 35-day funds, maturing Thursday, January 31, 2008. The third and fourth auctions will be held on January 14 and 28, with settlement on the following Thursdays. The amounts of those auctions will be determined in January. The Federal Reserve may conduct additional auctions in subsequent months, depending in part on evolving market conditions.
Depositories will submit bids through their local Reserve Banks. The minimum bid rate for the auctions will be established at the overnight indexed swap (OIS) rate corresponding to the maturity of the credit being auctioned. The OIS rate is a measure of market participants’ expected average federal funds rate over the relevant term. The minimum rate for the December 17 auction along with other auction details will be announced on Friday, December 14. Noncompetitive tenders may be accepted beginning with the third auction. The results of the first auction will be announced at 10 a.m. Eastern Time on December 19. The schedule for releasing the results of later auctions will be determined subsequently. Detailed terms of the auction and summary auction results will be available at http://www.federalreserve.gov/monetarypolicy/taf.htm.
Experience gained under this temporary program will be helpful in assessing the potential usefulness of augmenting the Federal Reserve’s current monetary policy tools--open market operations and the primary credit facility--with a permanent facility for auctioning term discount window credit. The Board anticipates that it would seek public comment on any proposal for a permanent term auction facility.
The Federal Open Market Committee has authorized temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will provide dollars in amounts of up to $20 billion and $4 billion to the ECB and the SNB, respectively, for use in their jurisdictions. The FOMC approved these swap lines for a period of up to six months.
Information on Related Actions Being Taken by Other Central Banks
Information on the actions that will be taken by other central banks is available at the following websites.
Bank of Canada
Bank of England
European Central Bank
Swiss National Bank (61 KB PDF)
Statements by Other Central Banks
Bank of Japan
Swedish Riksbank
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