Central Banks Fix Liquidity, Not Solvency Problems
Staff Writer, CNBC.com
Five of the world's largest central banks have announced a coordinated injection of dollars into banking systems, in response to growing concerns over liquidity problems in the euro zone. However, analysts say, they cannot solve the underlying solvency crisis.
The European Central Bank, US Federal Reserve, the Bank of England, the Swiss National Bank and the Bank of Japan announced three month repurchase operations on Thursday.
Earlier in the week, France's three largest banks – BNP Paribas , Societe Generale and Credit Agricole – had to face down rumors that they were unable to secure funding from US money market funds and were facing a shortage of dollars. BNP Paribas denied reportsin the Wall Street Journal that it could not get hold of the currency. A day later, Moody's downgraded SocGen and Credit Agricole. Shares in all three rose on news of the additional liquidity, as did the main European indexes.
The FTSE closed up 2.03 percent, the DAX 2.98 percent and the CAC40 up 3.16 percent as investors reacted to the announcement.
The action has recalled 2008, at the beginning of the financial crisis. Liquidity in the interbank market dried up in the wake of the collapse of Lehman Brothers.
With few, if any, measures to solve the sovereign debt crisis in the euro zone's periphery emerging, and reform of the existing mechanisms, such as the European Financial Stability Facility (EFSF), becoming bogged down in member states' politics, the market has been trading for any information that it gets hold of.
With markets finding in an impending liquidity shortage another reason to take fright, the central banks took action to prevent a concern from becoming a crisis.
"There's clearly been stress in the bank funding markets in the euro zone, there's no question of that. On the evidence that I have seen, that stress is nothing like what it was in 2008," Paul Donovan, global economist at UBS, told CNBC.com. "The banking system is functioning still. Money can be borrowed, it may not be borrowed at the terms one wants, it may not be borrowed at the duration one wants if you are a euro zone bank, but it can be borrowed."
The move should, Donovan said, stop an immediate escalation of the liquidity issues in the euro zone.
"This is a clear indication that central banks stand ready to provide liquidity in whatever currency is required to euro zone banks," he said. "What it does not do, clearly, is resolve any questions over solvency."
Despite the lack of coherence in policymaking, Thursday's intervention shows that at the very least, central banks have learned the lessons of 2008 and are able and willing to coordinate, at least in areas that are clearly within their remit.
"Providing liquidity to the financial system is pretty much the definition of what central banks are supposed to do."
The "mission creep" by central banks, particularly the ECB, since the beginning of the financial crisis, has concerned economists and bankers, analysts told CNBC.com. This intervention at the very least is a demonstration that they are capable of fulfilling their own roles.
"It gives us confidence that there will not be a liquidity crisis in the banking system and the lessons of 2008 have been learned. Money markets will continue to function. If there is a problem in money markets then central banks stand ready to substitute for that," Donovan said.
"Does this resolve the Greek debt problem, issues of asset losses in the event of a Greek default? No, clearly it doesn't do that. But it gives us confidence that liquidity is not a problem we will have to contend with in the wake of any expected Greek default."
For other analysts, however, the European portion of the intervention is yet another step taken by policymakers to avoid dealing with the underlying causes of market turmoil.
"It’s very much part of what I have coined: ‘Maximum Intervention’ – the final phase where policy makers extend-and-pretend one more time - This time with bigger ammunition," Steen Jacobsen, CIO at Saxobank
Europe's problem, Jacobsen noted, is not a liquidity one, but a solvency one. It is also, he said, pointing to the likely difficulties in the ratification of the EFSF by the German constitutional court in Karlsruhe, not likely to be resolved easily.
On the liquidity front, Jacobsen added, "This again exacerbates lending from central bank replacing inter-bank lending and trust."
"Hardly a step forward, rather one step forward and two steps back," he said. "This debt crisis has no good solution – the market and politicians are always looking for the quick-and-easy route and failing to address the fundamental issue: solvency."