The Federal Reserve injected $38billion into the banking system in three operations Friday, attempting to avert a credit crunch that could threaten the economy.
The central bank pledged to provide cash as needed "to facilitate the orderly functioning of financial markets."
It was the Fed's biggest one-day injection since it added $81.25 billion shortly after 9-11. The Fed added $24 billion on Thursday.
Since the subprime mortgage crisis is of American origin you might expect the biggest central bank intervention would happen in the U.S. of A. Nope. The European Central Bank made far larger cash injections into European banks.
PARIS -- As European stocks continued a steep fall today, the European Central Bank announced a new injection of $83.9 billion into the banking system to try to calm markets agitated by a crisis in U.S. mortgage loans.
The move followed the Frankfurt-based bank's previous infusion of $130.7 billion into the system Thursday. The outlay is in response to a sudden leap in lending rates after a French bank, BNP Paribas, froze three funds dependent partly on American sub-prime loans.
In all, central banks in Europe, Asia and North America have pumped out more than $300 billion over 48 hours in an effort to keep money flowing through the arteries of the global financial system, hoping to prevent a credit market seizure that could imperil economies.
The Federal Reserve added $38 billion to markets, the Bank of Japan $8.5 billion and the Reserve Bank of Australia $4.2 billion, signaling broad concern among central bankers.
European financial institutions are taking big losses in American mortgage bonds.
The European sell-off began Thursday with an announcement by BNP Paribas, France's largest bank, that it was halting withdrawals from three hedge funds with a total value of about $2.2 billion that had exposure to U.S. subprime loans. The bank's shares were down 4.4 percent Friday.
Bear Stearns triggered a decline in the credit markets in June after two of its hedge funds faltered as default rates on home loans to people with poor credit rose. For subprime mortgages turned into securities, defaults hit a 10-year high.
The company pledged $1.3 billion to help stem losses in the funds. They filed for bankruptcy protection on July 31, two weeks after Bear Stearns told investors they would get little, if any, money back. The firm then blocked investors from pulling money from a third fund as losses in the credit markets expanded beyond subprime-mortgage securities.
Another European fund valued at 750m was frozen too, and a Dutch bank pulled its planned new listing after suffering subprime losses. Back across the pond, the Wall Street Journal reported that a second Goldman Sachs Group hedge fund is also suffering losses and selling positions due to subprime worries.
The same day, NIBC, a midsize Dutch bank, said the subprime snafu had contributed to a $189 million loss in one of its U.S. investment books in the first half of this year. And dodgy real estate loans have made a big dent in forecasted earnings this year at German lender IKB.
The problem is that if sub-prime is doing badly then there is a risk that no one wants to buy structured products of any type. And that's one of the main reasons why the equity markets are falling.
There has been a lot of leveraged buyouts in the US helping push up the value of equities, financed by debt and underwritten by American and European banks.
In recent years financial market commentators argued over whether we were in a housing bubble. Well, the current bubble popping sound we are hearing in the financial markets indicates that, yes, we really were in a big real estate bubble.
What's becoming clearer by the day is that we're watching the unraveling of a global real estate financing bubble. The U.S. subprime market is the heart of the problem, but financial innovation has spread the risk around the world in a way that wasn't possible a generation ago. Long-term assets -- real estate -- have been financed by hedge funds with short-term debt instruments, and the amount of the debt now exceeds the value of the collateral in these subprime investments. Somebody is going to have to swallow the difference, and the challenge for regulators in both the U.S. and Europe is to assist this debt workout while protecting an otherwise healthy global economy.
How much will financial institutions and their stock holders be made to suffer for their folly? On the one hand we do not want a credit crunch so severe that it causes a global depression. On the other hand, financial institutions need to be severely punished by markets when they make mistakes. Unfortunately, it was the central banks who let the real estate bubble happen in the first place. I'm not expecting the central banks to accurately calibrate their response to this crisis.
|Share |||By Randall Parker at 2007 August 10 11:16 PM Economics Financial|