A run on the financial system
The financial crisis has hit a new level yesterday, the first day when you could a sense a panic that could evolve a general run on the financial system. Yesterday all measure of risk shot up to historic levels. The Ted spread, the yield difference between 3-month US government securities and 3-month money in the interbanking market, reached the highest level since 1987. It shot up 64bp yesterday to 283bp. The Ted spread is a widely used benchmark for distress in the money market, as it is almost a pure measure almost perceived counterparty risk. Investors fled into US government securities, apparently a safe haven, where yields on three month treasury bills fell to 0.06%, the lowest level ever. This morning, the crisis had spread to Asia, where the Hong Kong stock markets fell by 7%. An in Russia, the Moscow stock exchange has been close for the third day running.
Morgan Stanley, one of two independent investments banks still out there, also came under enormous pressure. The share price was down 44% at one point, and there have rumours all day yesterday about a merger with Wachovia. Perhaps even more worrying the credit default swap on MS almost touched 1000bp, as investors showed an unprecedented degree of risk aversion.
FT Alphaville notices that in previous moments of the crisis, government bailouts restored confidence. Not so this time. As of last night, the S&P 500 was down 4% on the day, the DJIA 3%, the Nasdaq 4%. The blog says that US liquidity has collapsed in the past few days. “The crisis in the short term debt markets is far worse than it was in August last year, or indeed in March, when Bear was bailed out.”
US government bails out the Fed
Technically, the Federal Reserve is broke, according to the US government, which has agreed to refinance the US central bank, after its serial bailouts. To that effect, the US Treasury started a temporary Supplementary Financing Programming, consisting of Treasury bills. FT Alphaville has a copy of the Treasury statement.
Calls to resurrect the Resolution Trust Company
Paul Volker, Nicholas Brady, and Eugene Ludwig have written in the WSJ – hat tip Calculated Risk – that for as long as the market is clogged with toxic real estate paper that does not repay according to its terms, the crisis will go on and get worse, “and we will have to ive through the mother of all credit contractions”. They are for a temporary resolution mechanism, similar to the RTC, which was set up to managed the bailed-out S&L in the late 1980s.
The worst regulatory failure of all time
Roger Altman, writing in the FT, calls it the greatest regulatory failure in modern history. He agreed with the authors above that some kind of RTC mechanism is ultimately necessary at huge cost to the taxpayer. He said the leverage these institutions took on is indefensible, averaging some 27 to one in mid-2007. He said it will take the US a long time before it gets out of this hole, maybe three or four years. In the meantime, the economy will be credit-constrained.
Rogoff on the future of the US
Kenneth Rogoff, writing in the Financial Times, calculates that the bailouts so far, including AIG, will add some $200-$300bn to the US national debt of $4400bn, which is not too bad, and would still keep US debt to GDP lower than in European countries. But he estimates that the total net bailout costs will be some $1000-2000bn. The really good news is that the US dollar has not yet collapsed, and that interest rates have not soared. But Rogoff seemed sceptical that this will last.
French hedge fund goes under
The Lehman collapse has had one of its first external victims in France, where the hedge fund ADI has got into acute difficulties. ADI has five funds specialising in credit arbitrage, according to Les Echos, which also said that this is not going to be the only victim of the Lehman collapse. Lehman was a counterparty as well as issuer of instruments the funds had bought.
Ooops. We gave Lehman €300m!
If you thought that we re-enter the golden age of the state-owned banking sector, just look at this hilarious story from Germany, where KfW – the bank the finance the reconstruction of post-war Germany – gave us another classic display of the incompetence of the state-owned banking sector. KfW mistakenly sent €300m to Lehman Brothers, after Lehman declared bankruptcy. Ooops. According to Frankfurter Allgemeine, the .bankers at KfW did actually spend the weekend discussion the counterparty risk involving Lehman, but apparently noone had notice that another payment was about to made on Monday. German politicians across all parties have reacted with fury. KfW has also been duped by IKB, the small German bank, whose liquidity crisis started the chain reaction in credit market last August.
Brussels sees Lisbon Treaty not before 2010
Le Monde reports that the Lisbon Treaty is unlikely to come into force in 2009, as more and more people think (including Jean Claude Juncker) that the Irish cannot and should not be rushed into a second referendum right away as the chances of success are virtually zero. This leaves the EU with an interesting problem, because under the Nice Treaty it is compelled to reduce the number of Commissioners to below 27. The plan is now to reduce the number to 26, while country No. 27 will get the job of foreign policy chief.
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