Posted on 12/12/2007 7:11:24 AM PST by Toddsterpatriot
WASHINGTON (AP) -- The Federal Reserve announced Wednesday it is coordinating with other central banks to deal with the global credit crunch. The central bank said it had reached an agreement with the European Central Bank as well as the Bank of England, the Bank of Canada and the Swiss National Bank to address what it termed "elevated pressures" in credit markets.
The Fed said that it was creating a temporary auction facility to make funds available to banks and was also setting up lines of credit with the European Central Bank and the Swiss Central Bank that could be used for additional resources.
The Fed said that commercial banks would be able to bid at auction for funds that would be drawn from the Temporary Auction Facility. The money would be intended to help cash-strapped banks raise money needed to keep making loans to businesses and consumers.
The action represented another step by the Fed to deal with a serious credit crunch stemming from the tightening of bank lending standards in the wake of multibillion dollar losses from a rising tide of defaults on mortgage loans.
The Fed's announcement came a day after it cut a key interest rate for the third time this year. That quarter-point rate cut disappointed Wall Street, which pushed the Dow Jones industrial average down by 294 points. Investors had hoped for a bolder response to the growing housing and mortgage crisis in the United States.
The Fed said all banks judged to be in generally sound financial condition by their Fed regional bank would be eligible to participate in the auctions for funds.
The first auction of $20 billion was scheduled for next Monday, followed by another auction of $20 billion on Dec. 20. The third and fourth auctions will be on Jan. 14 and 28.
The Fed said that the new auction process should "help promote the efficient dissemination of liquidity" when other lines of credit were "under stress."
The experience gained from the four scheduled auctions would be "helpful in assessing the potential usefulness" of this new process to provide funds to U.S. banks, the central bank said.
It said that the temporary swap arrangements being set up would provide up to $20 billion in reserves for the European Central Bank and up to $4 billion for the Swiss National Bank. The reserves would be available for a period of up to six months.
Since the global credit crunch hit with force in August, other central banks as well as the Federal Reserve have been injecting massive amounts of money into the banking system in an effort to keep credit flowing.
However, those efforts have only been partially successful. Many businesses and consumers report rising trouble in obtaining loans as banks become more fearful about extending credit in the wake of a surge in bad loans stemming from the U.S. housing crisis.
Where did you do that?
My uninformed opinion is they are coordinating because this is a global problem, and the more institutions involved will bring greater confidence to the markets.
I agree that this is a global problem — we’ve been seeing signs of that since August quite well.
What I’m not sure of is whether this increases or decreases confidence. Because this unprecedented effort without any background information is doing just the opposite for me - it leaves me asking more questions that they aren’t about to answer.
Every announcement by the Fed this morning on this deal makes it look more and more like they know there’s some huge, “can’t fail” bank that’s teetering on the edge, they all know it has ramifications for both the EU and the US (otherwise it would have been impossible to get both the ECB and BOE on board with the Fed on this deal), but they’re going to be real cute and not say who/what it is.
At times like this, I come back to one truth about the markets: they hate uncertainty.
Panic of 2007 ?
Reminds me of the Panic of 1907, after which JP Morgan used his own money to stabilize the system, precipitating the creation of the Fed in 1913.
After 100 years, the system is getting a little long in the tooth unable to deal with modern day financial engineering that has brought us the wonderful opacity of derivatives...
That would be WaMu or Citi, take your pick.
Zactly. The banks are hoarding their reserves because they may need them to stay solvent. So they don't want to originate new loans with the uncertainty.
When you're running a confidence game, nothing is more important than confidence.
The Fed's an experiment brought about by Progressives long gone awry. The idea of trusting our money, it's very definition and the amount in circulation, to politicians, has proceeded predictably enough. Either we need to return to the pre-Bretton Woods gold standard or at a minimum replace the Fed with a computer algorithm that keeps the total money supply within a 2-3% growth range, without adjustment by politicians and reliably forecastable for retirement planning.
Yes, they are using band-aids to stall the economy from entering recession until after elections. It is allowing less fiscally minded people to restructure loans now, reduce debts and curb wasteful spending. It is allowing more fiscally minded people to start preserving cash for the bargain basement real estate deals we’ll see in 2009 and make other preparations in case the entire floor falls out and the economy temporarily collapses. I assume under that circumstance martial law will be declared and supplies of necessary commodities such as food, clean water and medicines disrupted. Obtaining sixty day supply of food and water (or necessary medicines such as insulin for Diabetics) along with home protection would be a wise idea. Better to have it and not need it then need it and not have it.
If the worse does unfold, it will be a progression and a ME conflict would quickly turn something bad into some awful and time would quickly evaporate to be prepared.
So you understand, LIBOR is the London interbank offer rate, also known as the rate one bank charges another to lend them dollars, in the international short term money market. These are loans for short periods, from a day to a year, with 1 month and 3 months the most actively traded. At present, the rate on LIBOR loans is around 5%.
Meanwhile, US treasury bills with the same maturity trade for yields as low as 3%.
Normally these 2 figures track each other quite closely, because in normal money market conditions, the credit of one major international bank is almost as good as that of the US treasury, at least for a short enough time scale. A LIBOR rate only a quarter of a percent above T-bills, would normally induce banks to sell some of their T-bills and loan the proceeds out to other banks at LIBOR rates, instead. They make the difference, and the only risk involved is that a major bank somehow defaults on a time scale of a month or three - normally, an event considered horribly unlikely.
When instead the spread between LIBOR and T-bills is almost 2% - well, it means the money market is not functioning, that banks are not willing to engage in such exchanges, that they do not see the credit of other big banks as safe, or something of the sort. Right now, most major banks are trying to reduce their loans to each other, to save their loanable "ammo" for trouble in mortgages and related middleman entities.
The Fed is trying to get LIBOR down. Yesterday, they cut fed funds by a quarter point, and LIBOR actually rose. This was essentially unprecedented. This is basically a guess as to what is going wrong - they think that fed funds can't easily be turned into Eurodollars for lending abroad - the pool for LIBOR loans - and so they want to ensure that big European banks (and European branches of US ones) can lend more to the LIBOR market.
Part of the reason LIBOR is staying high, though, is it is the basis for about half of the floating rate mortgages outstanding, and also the basis for scads of swap contracts and other undisclosed derivatives. For adjustable mortgages to get cheaper, LIBOR has to come down. Making LIBOR drop will also create a new set of big winners and big losers in the swap markets, and nobody really knows who.
The very low yields on treasuries actually reflect a liquidity premium for them, in the sense that everyone knows you can always borrow against treasury bill collateral. While bank loans might easily get frozen in any mortgage related blow-up. Treasuries also require no reserves to carry as assets, so when a bank is trying to raise its free reserves, one way to do it is to carry fewer other loans (e.g. mortgages) and more treasuries. But everyone cannot do this - the amount of the other loans does not go down.
The real solution is for banks having difficulties to raise risk capital by doing share offerings, issuing preferred stock, reducing their dividends and share buybacks, etc. And to sell off riskier assets to financial entities that are less leveraged and can carry them with equity not short term debt. Right now they aren't doing the last of those because they are generally unwilling to mark down their mortgage assets to the fair market price, because the fair market prices are so low - 27 cents on the dollar for a subprime portfolio e.g.
Will this action help? Sure. Will it solve the problem? No. Only the banks biting the bullet on their losses, and raising capital or selling assets or both, can actually ease the pressure.
Incidentally, the trade to buy LIBOR (bet that LIBOR rates will go down eventually) compared to currently super low treasury rates, is a good trade right now. Risky in the short term, and could take a couple of years to return to normal. But 2-3 years from now, the spread between LIBOR and treasuries is *not* going to be nearly 2%, but much much less. FWIW...
Great information and learn something new every day.
“It is essential an admission that they were shocked by the market reaction to their quarter point cut yesterday.”
I’m with you except for your first sentence, quoted above. There’s no way to put together that kind of agreement in 18 hours. It had to have been in the works for some time. The FED understood the problem of rate cuts ceasing to have the desired effect, and needed to save some bullets for next year. LIBOR is the problem, good analysis there. I’m not going to dive in for that LIBOR buy, but I am going to open positions in short and medium term Corp Bonds.
If that agreement was put together in 18 hours, we should all be buying canned goods, water and ammo.
“They pulled the trigger after seeing the reaction. Of course they have numerous options lined up, and do all the time.”
JasonC, you are a smart guy, c’mon. When you step in it on one minor point, just admit it and move on. You’ll look better for it. Ben didn’t make panic calls all over the world last night and “pull the trigger” because the market averages went down 2%. He launched a planned one-two punch. He knew the initial reaction would be negative, and he did things in just the right order. Now we’ll see if it works.
As for the Fed chairman, he has yet to impress me on any point. Before or after talking his present position. I consider the entire crowd running this stuff today to be way over their heads, and riding a hurricane.
Very well. Your opinion noted that you know more than the FED governors. What would your course of action have been, now that you have the advantage of hindsight?
Thank you for the discussion.
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