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Busch: Big Worldwide Moves And What They Mean

Monday, 13 Oct 2008 | 9:59 AM ET

Australia guaranteed all deposits with financial institutions for the next three years and guaranteed all "term wholesale funding" by Australian banks operating in international credit markets. The RBA injected A$2.849 billion into their system. New Zealand said it will guarantee retail deposits in NZ registered banks, building societies, credit unions, and deposit-taking finance companies.

UK will provide up to 37 billion pounds ($63.95 billion) buying into top 3 UK banks of RBS, LBI, and Barclays. In a stunning move, RBS and HBOS will be nationalized as the government takes a majority shareholding in both banks. The RBS action was a stunner as the market was not anticipating this move. PM Brown said he was "genuinely shocked" when he was told how much cash was needed to recapitalize RBS.

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It underscores how close the firm was to experiencing extreme difficulties. "Those banks which become majority owned by the state will also be state-run, with Government-appointed board members put in place to ensure the banks begin lending to businesses and individual customers again, " according to Reuters. Here's a good review: UK Crisis

Germany has pledged E400 billion in loan guarantees, providing as much as E80 billion to recapitalize banks in distress, and to set aside another E20 billion in its budget to cover potential losses from loans. France is expected to announce similar programs. In a move to ensure massive liquidity, the ECB, the BOE, and the SNB will auction unlimited dollar funds with maturities of 7, 28, and 84 days at a fixed interest rate.

From the US, Reuters reports that the Morgan Stanley-MisubishiUFJ deal is going through with an investment dividend of 10% and a right to maintain equivalent of 20% fully diluted ownership. This was an important deal to have go through and hopefully will stabilize MS. Also, we had Tsy Ast. Sec. Neel Kashakari (in charge of TARP) surface to announce that, "We are designing a standardized program to purchase equity in a broad array of financial institutions. The equity purchase program will be voluntary and designed with attractive terms to encourage participation from healthy institutions."

Clearly, these aggressive actions should temporarily arrest the free fall that equities have been in and ease the uncertainty over deposits and bank lending. Interbank lending has been frozen and non-bank lending is almost non-existent. Guaranteeing lending out 3-5 years should get banks and customers willing to provide capital for these loans. However, there are many steps left to take to resolve the credit crisis. The recapitalization of banks is critical as is the merging/submerging of weak institutions. Time must be taken now to audit banks assets and close the weakest links in the financial chain. This mess must be cleaned up to have a longer term positive outcome.

The structure of how the TARP program will be structured and how the governments guarantee lending. There are potential problems from massive asset growth by financial institutions to capital adequacy. From Japan's problems from 1992 to today, one of the major lessons learned was getting banks to participate in the programs. This can be accomplished by nationalizing banks like the UK, but more likely will be the government setting a high price for securities it is going to purchase. You will know TARP is a success or failure by the amount of participation by US banks.

The key for now is to stabilized the banking system. Collectively, the actions by governments across the globe will help and should work temporarily. These programs are bridges to further policy action and audits of bank assets. I believe these will work and provide a temporary bottom to the equity markets. The litmus test is to watch Libor to OIS spreads and the TED spread to see if these ease. Then, we'll know if the programs are working. So far, they haven't moved much.

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    Andrew Busch

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