A group of central banks made up of the US Federal Reserve, the Bank of Canada, the European Central Bank, the Bank of England, and the Swiss National Bank tried to work in unison to inject cash into credit markets to try to unfreeze them.
The Bank of Canada joined the U.S. Federal Reserve and other central banks yesterday in an audacious attempt to ease choked credit markets without resorting to inflation-stoking interest-rate cuts.
Analysts said the moves, billed as the biggest act of coordinated economic co-operation since 9/11, could be a novel way to get borrowing rolling again or a costly mistake if markets fail to respond and the freeze in borrowing drags on.
Not much happening here kids. Just most of the big central banks trying to act in unison to reverse a worsening global financial crisis. What, me worry?
This action is apparently unprecedented in scope.
If there is a precedent for yesterday's joint operation to inject liquidity into the international finance system by the western world's five leading central banks, we have yet to find it.
There was some co-ordination of activity after 9/11 but this operation is of a wholly different magnitude. The new multi-billion dollar facility is the starkest illustration yet of the alarming scale of the collapse of credit - and a welcome sign that central banks are treating it with the seriousness it deserves.
We have this size of crisis and world oil production hasn't even started to decline rapidly. Wait till that happens and this crisis will seem like small potatoes in comparison.
They certainly gave it the good old college try. But oops, darn it, the attempt looks like a dud.
The biggest concerted effort by central banks in six years to restore confidence in global money markets is showing little sign of success.
The rates banks charge each other for three-month loans held at seven-year highs for a second day after policy makers in the U.S., U.K., Canada, Switzerland and the euro region agreed to ease the logjam in short-term credit markets. The cost of borrowing in euros stayed at 4.95 percent, the British Bankers' Association said today, up from last month's low of 4.57 percent and 3.68 percent a year ago.
Noone knows how to value huge quantities of SIVs and other obscure debt instruments. Any institution that holds lots of them has a balance sheet that can't be deciphered. What is Citibank worth? That's an extremely speculative question. Is Morgan Stanley or Chase solvent? Hard to tell. A lot of investors thought our markets are very transparent and now they discover they can't trust debt ratings issued by Fitch, Moody's or Standards & Poors.
The ratings agencies are paid by the very organizations that want their bonds to get high ratings.
Rating agencies face a similar conflict to that of independent experts – that is, they are paid by the very people upon whom they are assessing. Ratings agencies are paid hefty sums by bond issuers to assess the creditworthiness of the asset. Moody’s is a stand-alone publicly listed company on the NYSE, while S&P is part of publisher McGraw Hill – both have to earn a return for shareholders.
Regular (non central) banks are afraid to lend each other money.
While yesterday's joint move was sketched at the G20 a month ago, and fine-tuned in encrypted telephoned calls over the past month, the final trigger seems to have been the spike in the crucial three-month money rates that lubricate finance. Dollar and sterling Libor spreads have vaulted in recent days. Euribor spreads reached an all-time high of 99 yesterday morning.
"A co-ordinated move like this has the 'wow factor'," said Paul Mackel, currency strategist at HSBC. "But there's a lot of scepticism over whether this will be enough medicine to end the credit crisis. Is it already too late?"
It is unusual for so many banks to engender fear all at the same time.
Central banks in Europe and North America unleashed a powerful and rare arsenal of liquidity measures Wednesday meant to stave off the threat of a steep deterioration in credit conditions over Christmas.
But analysts fear the measures will only delay the inevitable balance sheet pain and market turmoil that is necessary to purge shaky debt securities from global markets. And Bank of Canada Governor David Dodge conceded he was unsure the measures would have a lasting effect.
“It's very unusual. But it's also very unusual to see all the world's banks at such risk,” said Sherry Cooper, chief economist at BMO Nesbitt Burns Inc.
“They wouldn't be doing this if they didn't know this situation is very serious.”
Dr. Irwin Kellner sees parallels with the 1930s liquidity trap.
Today there are some similarities to the liquidity trap of the 1930s. The credit crunch is clearly one of them. No matter what the Fed does on Tuesday, it will not be able to thaw out the frosty financial markets.
This is because the markets lack confidence. As I wrote two weeks ago, "fear, and not a lack of liquidity, is what's freezing up the credit markets ... and ... it's going to take a lot more than infusions of liquidity to thaw them." See Nov. 26 column
You know that fear is stronger than greed these days when banks refuse to lend to each other - never mind to businesses or to consumers.
A good indication of this is the three-month LIBOR spread against comparable maturity Treasuries. It's over 200 basis points (2 percentage points) today versus an average of about 25 bps between 2003 and this past spring.
The banking industry is experiencing a crisis in trust.
What scares the central bankers now is the evaporation of trust from the system. Banks don't believe each other's numbers; since nobody knows the real value of some of the mortgage-backed securities everyone is holding, they assume the worst. They start hoarding cash as a buffer against their own losses and because they're nervous about lending to anyone else.
I hope the central banks can prevent a much larger crisis and just limit the fall-out to a moderate recession.
Geez, this suggests there's a problem in the securities market that could snowball.
Several of the world’s biggest banks are in talks to put up about $75 billion in a backup fund that could be used to buy risky mortgage securities and other assets, a move designed to ease pressure on a crucial part of the credit markets that threatens the broader economy.
Citigroup, Bank of America and JPMorgan Chase, along with several other financial institutions, have been meeting to come up with a plan to create a fund that could prevent a sharp sell-off in securities owned by bank-affiliated investment vehicles. The meetings, which began three weeks ago, have been orchestrated by senior officials at the Treasury Department, and the discussions have intensified in the last few days.
If only we had access to a bunch of parallel universes we could find out if funds like this one are needed in order to prevent market meltdowns and global depressions.
Should we react to this news by thinking that wise big money knows how to prevent calamity and big money is motivated enough to prevent a depression? Or should we react by thinking that our financial system isn't all that stable and economic panics are still quite possible?
Daniel Gross, writing for the New York Times Magazine, reports signs that New York City is rapidly ceasing to be the preeminent financial capital of the world.
Some of the trends highlighted in these reports are troubling for the United States financial-services industry and for New York, its spiritual and historical home. The Committee on Capital Markets Regulation noted that the U.S. share of global initial public offerings — those outside the company’s home country — fell from 50 percent in 2000 to 5 percent in 2005. Until recently, the directors of China Construction Bank would have seen no alternative to a New York offering. Only New York had the experienced underwriters, the highly transparent, trustworthy markets and the deep pool of capital to handle such a deal. That’s no longer the case. In 2001, New York’s stock exchanges accounted for half of the world’s stock-market capitalization. Today, the total is more like 37 percent. In 2005, 9 of the 10 largest I.P.O.’s took place outside the United States. The world’s largest-ever I.P.O., the $19.1 billion offering of Industrial and Commercial Bank of China, was staged in Hong Kong in 2006. In the lucrative field of investment banking, sales and trading revenues, the McKinsey report concluded that “European revenues are now nearly equal to those in the U.S.”
Part of this is driven by technology. Trading floors are getting replaced by totally automated computerized trading. The buyers and sellers still exist scattered over many cities and countries as they always were. But there is less need for traders at the center making a market in securities. Automation is reducing labor needs. But also communications and computing technologies are reducing the need for concentrations of workers to enable them to come into close physical proximity with each other.
New York City has a great deal to lose from outsourcing.
What does all this diffusion mean for New York’s economy? Potentially, a great deal. Steve Malanga, senior fellow at the Manhattan Institute, estimates that there are 175,000 securities-industry jobs in New York, which pay an average wage of $350,000. The Committee on Capital Markets Regulation notes that the securities industry accounts for 4.7 percent of the jobs in New York City but 20.7 percent of the wages. But the impact is even larger, since the spending of Wall Street hotshots supports a huge number of other jobs. Between 1995 and 2005, the sector grew at an average annual rate of 6.6 percent in New York and provided more than a third of business income-tax revenues, according to McKinsey.
Will the high income jobs leave New York City? Will financial work diffuse across many more countries and cities?
The high cost of doing business in New York combines with technologies that eliminate the need for close physical proximity. The result is that new companies can start up in lower cost locations and rapidly grab big chunks of market share away from NYC-based companies.
Because of the high costs of living and doing business in New York, the city is likely to continue to lose market share. Take the case of BATS, an alternative trading platform based in Kansas City, Mo., that has come out of nowhere to gain a 9 percent share in the market for trading United States stocks. “Our location is one of the principal factors that enabled us to go from start-up to the third-largest equities exchange in the U.S. in a matter of 18 months,” says Joe Ratterman, its president and chief executive officer. The company’s computers reside in a New Jersey data center, and it has two sales representatives in New York. But the rest of its 33 employees work out of a 10,000-square-foot office complex with views of downtown Kansas City.
Think about that. 18 months from start-up to 9 percent market share. New York City's financial worker employment could suffer shrinkage far more rapid than what happened to the smoke stack manufacturing industries back in the 1970s and 1980s.
Gross speculates that New York City can still survive by becoming a services economy which caters to the needs of the super wealthy. The city still has the lawyers, accountants, investment bankers, and other skilled workers that allow complex deals to get put together in face-to-face meetings. But anything automated strikes me as better done in lower cost locales.
The rise in oil prices, accumulating debt burdens, the bursting of the housing bubble, and the large US trade deficit have pushed down the US dollar. The long expected adjustment of currencies is taking place. Also, foreign buying of US securities has declined as the dollar has weakened.
Even before the recent market turmoil began, foreign buying of U.S. financial assets had slowed. A Treasury Department report showed foreign holdings of long-term securities such as equities, notes and bonds increased by a net $19.2 billion in July, the slowest pace in seven months and well below the $97.3 billion tallied in June.
Worries about foreigners wanting to diversify out of dollars rose last week after Saudi Arabia decided for the first time not to cut interest rates in lock step with the U.S. Fed, leading to some speculation that it would soon end its currency's peg to the dollar.
A decline in the dollar combined with a decline in foreign investments creates inflationary pressures in a few ways. First off, imports cost more. Second, the drop in the dollar also increases foreign demand for US goods and therefore enables US manufacturers to raise places. Third, the decline in foreign purchases of bonds raises interest rates. All these forces are inflationary. If strong inflation shows up then the US Federal Reserve will have to raise interest rates and push the US economy into a recession.
The Middle Eastern nations no longer use their oil revenue to buy goods from the United States.
What happened? Oil nations are more willing to diversify out of the dollar than they used to be, said Mansoor Mohi-uddin, the head of foreign exchange strategy at UBS, in Zurich.
Stephen Jen, the global head of current research for Morgan Stanley in London, agreed. "Oil exporters' propensity to import from the U.S. has declined in recent years, while their tendency to import from Europe and Asia has risen steadily," he said, adding that OPEC nations currently buy more than three times as much from the European Union as from the United States.
The recent decision of the Saudi central bank to not follow the US Federal Reserve in lowering interest rates indicates the Saudis may be headed toward breaking their dollar peg. The Saudis import most of their goods from the European Union and the rise of the Euro against the dollar has caused a high rate of inflation in Saudi Arabia. By letting their currency rise against the dollar they will reduce their cost of imported goods from Europe and lower internal prices.
Foreign cash flows into US securities has even reversed.
The tally for all of the third quarter isn't yet in, but last week we learned what happened to some of these investment flows in July. Net foreign purchases of U.S. stocks dropped to $21 billion, from $29 billion in June. Net foreign purchases of U.S. corporate bonds slumped to $4 billion from $26 billion the prior month as the incipient credit crunch throttled global demand for junk. All that spare cash flowed into short-term debt, which saw an inflow of $67 billion after an outflow of $28 billion in June. Meanwhile, counting stock swaps and the repaid principal on bonds, foreigners actually took $3 billion more out of long-term U.S. securities than they put in.
Americans have been living beyond their means, importing more goods than they exported. American living standards may stagnate or fall during the readjustment that will bring imports and exports back into balance. That readjustment will be a contributing cause of the next recession.
Even East Asian bondholders are becoming reluctant to buy US financial paper.
The dollar's slump to a 15-year low against six of its most actively traded peers is turning the gains into losses for international bondholders, prompting China, Japan and Taiwan to sell. Overseas investors own more than half of the $4.4 trillion in marketable U.S. government debt outstanding, up from a third in 2001, according to data compiled by the Treasury Department.
``The support that Asia has shown in buying U.S. Treasuries has been a major supporter of keeping long-term interest rates lower than where they probably would be,'' said Gary Pollack, who oversees $12 billion as head of fixed-income trading in New York at the private wealth management unit of Deutsche Bank AG, Germany's biggest bank. ``This could put some upward pressure on yields in the United States.''
Higher long term interest rates will raise mortgage payments and further dampen demand for housing and therefore cause more of a housing price decline. This produces winners and losers. It is good news for people who want to buy a house a few years from now.
China's emergence in the early 1990s as the low-cost workshop of the world furnished global markets with an endless supply of cheap goods, creating stiff competition that kept down prices everywhere. For a time, that effect more than offset costs for raw materials, notably oil, which also began to rise as China, India and other emerging economies began to develop.
Now, however, these populations can increasingly afford to live a little better, driving a new spiral of demand for building materials to accommodate expanding infrastructure; foodstuffs to feed cattle as more meat is put on the table; and oil to fuel new cars and more manufacturing.
Over the past five years alone, oil prices have risen 158 percent, to around $80, while the price of wheat has soared 126 percent. Costs for nickel, used to build Alno's sinks, have shot up 415 percent.
The price of food has been rising like the price of oil and for similar reasons.
"Food is going to be like oil," a product that gets more expensive as China and India get richer, said Chris Williamson, chief economist at NTC Economics in London.
Alan Greenspan fears higher long term inflation is coming.
The former chairman of the U.S. Federal Reserve, Alan Greenspan, is doubtful. In his new memoir, he writes that inflation could hit 4 percent to 5 percent in a decade, enough to halve the purchasing power of a dollar in about 15 years.
As salaries continue to rise in China and as Chinese demand pushes up costs of raw materials the Chinese manufacturers are beginning to raise prices and economists expect they will continue to do so. China will shift from being a deflationary force on prices to being an inflationary force.
The burst of the housing bubble has caused the Federal Reserve's to use lower interests rates to try to avoid a recession. But inflationary pressures might force the Fed to eventually shift gear on interest rates.
If the Fed gets it just right, the economy will slip through this crisis and keep expanding with only modest inflation, making investors happy. If the Fed's rate cuts are too little, too late, recession fears will return, sending another cold wind through credit markets and the stock market. If the Fed cuts rates too much, inflation could loom.
What was troubling some investors after the Fed rate cut last week, a reduction in short-term rates by half a percentage point, to 4.75%, was the latter risk -- the risk of inflation.
If rising inflation forces a rise in interest rates then the US economy could go into recession.
Some money managers already are warning that inflation may force the Fed to raise rates early next year, taking back last week's gift. Higher rates would hurt stocks because they stifle the economy and make it harder for investors to borrow.
Something similar happened in 1999, when the Fed had to raise rates after cutting them during the 1998 financial crisis. The economy ended up in recession in 2001.
The recession will be uneven. Some exporters will experience sales growth made possible by a weakening dollar.
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.
All of the central banks have injected over $300 billion so far.
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.
More financial institutions keep popping up with big subprime mortgage losses.
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.
Smaller European banks are getting hit by losses in the US mortgage market too.
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.