Ease money-market crisis by letting banks go bust
The banking community wants central banks to tackle hangover and refill the punchbowl by cutting policy rates.
By Agencies |
LONDON: Call it deja-vu all over again. “A further important cause for alarm was the danger that the troubles, if not solved, would be transmitted through a domino effect to the many other secondary banks which, with much vulnerable short-term borrowing and many assets tied up in the increasingly troubled property industry, were themselves showing signs of being at risk in the harsher new economic environment.” Sounds like an apt, if somewhat wordy, description of the current money-market crisis prompted by the collapse of the US subprime mortgage market, doesn’t it?
Instead, the passage is lifted from “The Secondary Banking Crisis, 1973-75” by Margaret Reid. The book describes how the collapse of a UK mortgage lender called Cedar Holdings triggered a crisis of confidence in the banking system, requiring a Bank of England bailout.
Many of the similarities between today’s financial environment and the one prevailing more than three decades ago are striking — except for the part where the central bank rides to the rescue by strong-arming a posse into action. Banking is essentially a confidence trick. Depositors have to be confident they can draw freely from their accounts. Retailers have to be confident swiping a rectangle of plastic in exchange for goods and services will produce a balance transfer in their favour. And the banks themselves have to be confident they and their peers have sufficient assets to meet their liabilities.
For now, that confidence has evaporated as hedge funds and structured investment vehicles and conduits — spawned while the credit-market party was hopping — come knocking at the door for handouts because the music has stopped. And thus, the banking community wants the central banks to soothe its hangover and refill the punchbowl by cutting official interest rates. It’s far from certain that lower central-bank rates would unfreeze the money markets.
Moreover, central bankers are probably willing to sacrifice smaller lenders so the pain is enough to make financiers more cautious about future investments, provided there’s no threat to general stability. The US Federal Reserve and the European Central Bank have held special auctions to grease the wheels of commerce with extra cash. They have succeeded in driving the overnight rate for dollars down to about 5.18% from as high as 5.96% and its euro counterpart to 4.15% from 4.69%. Three-month rates, though, are stuck at a seven-year high of 5.7% for dollars and a six-year high of 4.82% for euros.
The Bank of England, by contrast, has been adamant that it won’t rescue the money markets by accepting low-grade collateral, or by offering three-month cash. Indeed, the Fed and the ECB were rebuked on Wednesday, albeit obliquely, by UK central bank governor Mervyn King for bailing out commercial banks. “The provision of such liquidity support undermines the efficient pricing of risk by providing ex post insurance for risky behaviour,” King told the UK Parliament’s Treasury Committee on September 20.
Instead, the passage is lifted from “The Secondary Banking Crisis, 1973-75” by Margaret Reid. The book describes how the collapse of a UK mortgage lender called Cedar Holdings triggered a crisis of confidence in the banking system, requiring a Bank of England bailout.
Many of the similarities between today’s financial environment and the one prevailing more than three decades ago are striking — except for the part where the central bank rides to the rescue by strong-arming a posse into action. Banking is essentially a confidence trick. Depositors have to be confident they can draw freely from their accounts. Retailers have to be confident swiping a rectangle of plastic in exchange for goods and services will produce a balance transfer in their favour. And the banks themselves have to be confident they and their peers have sufficient assets to meet their liabilities.
For now, that confidence has evaporated as hedge funds and structured investment vehicles and conduits — spawned while the credit-market party was hopping — come knocking at the door for handouts because the music has stopped. And thus, the banking community wants the central banks to soothe its hangover and refill the punchbowl by cutting official interest rates. It’s far from certain that lower central-bank rates would unfreeze the money markets.
Moreover, central bankers are probably willing to sacrifice smaller lenders so the pain is enough to make financiers more cautious about future investments, provided there’s no threat to general stability. The US Federal Reserve and the European Central Bank have held special auctions to grease the wheels of commerce with extra cash. They have succeeded in driving the overnight rate for dollars down to about 5.18% from as high as 5.96% and its euro counterpart to 4.15% from 4.69%. Three-month rates, though, are stuck at a seven-year high of 5.7% for dollars and a six-year high of 4.82% for euros.
The Bank of England, by contrast, has been adamant that it won’t rescue the money markets by accepting low-grade collateral, or by offering three-month cash. Indeed, the Fed and the ECB were rebuked on Wednesday, albeit obliquely, by UK central bank governor Mervyn King for bailing out commercial banks. “The provision of such liquidity support undermines the efficient pricing of risk by providing ex post insurance for risky behaviour,” King told the UK Parliament’s Treasury Committee on September 20.
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