Joint central bank action to halt
an economy-sapping rise in interbank lending rates was never on
its own going to solve this year's credit crisis but, like past
Group of Seven forays, it may help to turn the tide.
Five of the world's top central banks, including or with the
backing of all G7 members, coordinated a series of emergency
cash injections to their banking systems this week and finally
seem to be regaining traction over gummed-up money markets.
The U.S. Federal Reserve, European Central Bank, Bank of
England and others offered tens of billions of dollars, euros
and pounds through Monday and Tuesday to banks facing year-end
funding concerns due to cash-hoarding by their peers.
The root of the problem for both the banks and wider economy
remains a severe U.S. housing downturn and a resultant hiatus in
mortgage bond markets. But the key symptom has been surging
interbank lending costs that provide bellwethers for everyone.
With the symptom as toxic for the wider economy as the
underlying problem, there will be no small relief that the
central banks' united front has at last started to drag money
market rates lower after four months of intense pressure.
Although still more than half a percentage point above
central bank base rates, benchmark three-month London interbank
offered rates (Libor) started to fall in earnest on Tuesday.
Three-month euro Libor rates, for example, clocked up their
biggest one-day decline in almost six years and two-week rates
dropped more than half a percentage point as the ECB flooded
banks with almost 350 billion euros of two-week funds.
Sterling and dollar rates also fell.
So-called "normalisation" of money market rates -- which
would see three-month rates back down to about 15 basis points
above base rates -- will probably take several weeks or months.
But G7 banks acting in concert may well represent the high
water mark in the crisis, many analysts said.
"Investors dismiss too easily the likely impact
of the joint liquidity intervention," said Stephen Jen, Morgan
Stanley's global currency strategist, said in a note to clients.
"While the liquidity provisions will obviously not solve the
solvency problems that plague much of the financial sector of
the developed world, (it) reminds me of the typical market
reaction to joint currency intervention," said Jen.
"Investors tend to dismiss and belittle the official
efforts, until eventually proven wrong."
Jen added that he believed policymakers would now do what it
takes to thaw the freeze, at least the part they can influence.
G7 FX HISTORY
Although G7 intervention on money markets is unprecedented,
there are many parallels between this week's action and past
currency market intervention.
Since the Plaza and Louvre accords successfully weakened and
then supported the U.S. dollar in the 1980s, concerted central
bank FX action has frequently been dismissed at first by traders
as insufficient to buck the market.
A typical argument has been the inability of the authorities
to influence a market turning over more than $3 trillion a day.
Yet, repeated bouts of dollar purchases by top central banks
in 1995 marked the greenback's trough that decade. The next G7
raid late in 2000, followed up by unilateral ECB action, also
marked the beginning of the euro's long recovery.
Not unlike this week's money market intervention, the
amounts of new money committed by central banks back then were
What really counted was a united signal, the implicit
promise of repeated action and ultimately monetary policy
changes. The timing was also typically calculated to glean
maximum impact for minimum bucks -- in effect, nudging a market
that was about to turn anyway.
This week's Term Auction Facility programmes are similarly
modest in size at just over $60 billion and the relatively small
amount available was one initial criticism last week.
But the auctions have been supported by central banks
cutting penalty rates charged for emergency borrowing, ensuring
anonymity for borrowers and widening the collateral pool.
The timing may prove critical this time around too.
Libor rate premia over official rates had been edging higher
in the weeks preceding the announcement but the daily rises were
getting smaller and smaller and most players should have had
year-end funding secured by the time of the Dec 12 announcement.
"Interbank rates appear elevated but the volumes most
definitely are not," said Nick Parsons, chief market strategist
at nabCapital. "It's impossible to get accurate data but
whatever rates are being posted do not reflect funding volumes,
which are substantially lower than we'd have seen previously in
November or December."
Parsons said that interbank rate setters and central banks
are in "the biggest ever game of chicken" into year-end.
The true success of the central bank moves and the real
stress in the market will only likely be evident come the second
week of January, he added.
But most analysts agree that while rates may have come up in
the elevator, they will go down the stairs.
Residual concern about counterparty risk in interbank
lending is likely to persist until most banks report their
fourth quarter and year-end results through February
"To say this is just a year-end thing and it will all be
fine come January is just not plausible. This is not Y2K," said
David Brickman, European credit strategist at Lehman Brothers,
referring to concerns eight years ago that the date change on
Jan 1, 2000 would see widespread computer failure.
"This will help, as will the New Year turn -- but Libor will
The European Central Bank and Bank of England flooded money markets with funds on Tuesday as the UK central bank chief warned of a possible "self-reinforcing" downward spiral in credit.
The Bank of England (BoE) charged a minimum bid rate of 5.36 percent for its offer of 10 billion pounds of 3-month money, as part of a coordinated action with other central banks to ease market tensions by offering cash at favorable rates.
The money was taken up, though demand was muted. Previous similar auctions had failed as the BoE had set a minimum rate way above the main lending rate and no bank wanted to be seen as desperate for cash.
"In the last four weeks, banks themselves have been worried that the impact of their reluctance to lend will lead to a sharper slowdown in the United States," Bank of England Governor Mervyn King told a parliamentary committee.
"That concern is a serious one because it does hold out the prospect that there will be a self-reinforcing downturn in credit and activity."
The ECB scrapped the usual upper limit on how much it lends to banks in Tuesday's refinancing operation, offering two-week money to ensure lending rates stayed close to its target of 4 percent.
Banks Rush In
Banks clambered in, bidding for a hefty 348.6 billion euros ($500 billion) at a 4.21 percent lowest rate. Two-week Euribor interbank rates fixed sharply lower in response.
The offer was the first time the ECB has said it would meet all banks' refinancing bids above a certain rate since its first liquidity injection on August 9, as the credit crunch blew up.
"They're throwing everything they can at the liquidity problem," said one trader.
On Monday, the ECB offered $20 billion of 28-day funds at auction as part of the joint plan by leading central banks to alleviate strains in the interbank lending market.
The Federal Reserve offered a similar amount, while the Swiss National Bank (SNB) offered up to $4 billion at a discount to the Fed's existing discount rate.
Results of those auctions are due on Wednesday.
Most experts say the joint action, whereby the Fed, SNB, ECB, BoE, Bank of Canada and others provide fresh short-term lending, is unlikely to solve the crisis alone.
U.S. subprime mortgages -- lent to people ill-equipped to pay them back -- were bundled up into complex financial products and sold on around the globe.
Only when uncertainty has been resolved as to where the exposure lies are commercial banks likely to lend money freely to each other again on the interbank market, which oils the global economy's wheels.
"Large banks are now awash with cash. The issue is not whether they have enough cash, it is whether they are inclined to lend," King said.
Bank Results Loom
Three of Wall Street's biggest investment banks and brokerage firms will report quarterly earnings -- Goldman Sachs on Tuesday, Morgan Stanley on Wednesday and Bear Stearns on Thursday -- giving further insight into the amount of damage being done to balance sheets.
Expectations are high for Goldman Sachs to report another strong quarter even as its peers face write-downs and other problems from the subprime mortgage crisis.
Others have escaped far less unscathed.
Financial firms have to date written down more than $65 billion in credit-related losses. With official estimates of total losses from the subprime mortgage debacle around $300 billion, investors are braced for further shocks.
Britain deepened its involvement in stricken mortgage bank Northern Rock on Tuesday, offering to guarantee more of its liabilities as the struggle to find a private sector acquirer for the business continues.
Northern Rock is being auctioned off after a funding crisis in September forced it to borrow 25 billion pounds from the Bank of England, but that process has been thrown into doubt, with several suitors withdrawing.
In Australia, shares in Centro Properties Group slumped another 69 percent on fears its exposure to the subprime crisis will sink the company, but analysts said other Australian property firms were unlikely to face similar problems.
Centro warned on Monday it was having trouble refinancing A$1.3 billion ($1.1 billion) in debt and may have to restructure.
Australia's central bank saw strong reasons for a rise in interest rates at its December policy meeting but held off because of the credit squeeze, minutes of the meeting showed.
The European Commission said the global credit crunch would curb euro zone economic growth in the coming quarters but activity will be supported by robust employment and record-high corporate profitability.