Global money markets have effectively collapsed
The stress in the money markets deteriorated sharply yesterday. The FT reports that these problems outweigh the increasingly likely passage of the $700bn Paulson plan. 3-month dollar Libor went up 12bp to 3.88%. The TED spread – the difference between 3 month money and 3 month Treasury bills, and a good indicator of money market stress – went up to an all-time high of 3.44%, despite massive, balance sheet bursting liquidity injections by the Fed. The interest rate in the latest ECB auction of overnight dollars went up to 11%. The ECB also reported that banks had deposited a record €44.4bn overnight on Monday at the deposit rate, which is a full percentage point below the repo rate. This is an act of sheer despair, as banks shun the money markets now almost completely, with the central bank become the one and only guarantor of liquidity. The FT reports that the ECB has injected an extra €120bn into the money markets for the next 38 days in the vein home to stabilise them.
Here is the TED spread from Bloomberg.
(A short note by us. The problem with the coverage of the financial crisis in many European newspapers is that journalists are focusing too much on equity markets, and not nearly enough on the money markets, probably because they are more familiar with the former than the latter. This crisis, however, plays out in the latter. Yesterday’s light recovery in the equity markets, welcome as it may be, is almost a non-event in this crisis.)
There is a lot of debate whether the central banks’ liquidity operations are sustainable in the long run. At the moment they are self-financing, but that may not be the case forever, and the Fed may already have crossed the line. There is also a debate whether central banks’ inundation of liquidity might be make things worse for the money markets (kind of a crowding out argument). Pierre-Antoine Delhommais in Le Monde says the real question is whether the governments can save money markets and the financial system without endangering their own creditworthiness. By nationalizing the failed banks governments of the industrialized countries risk to ballooning public deficit which could trigger a confidence crisis among investors that gets the governments into financing difficulties. There is then no longer a lender of last resort to confort with.
CDS market faces test in October
The FT has an interesting article about the market for credit default swaps, which faces its biggest test this month, as many CDS contracts relating to the failed Fannie Mae, Freddie Mac, Lehman Brothers and Washington Mutual are settled. CDS are a type of bond insurance, which get triggered when the insured bond defaults, or even by other trigger events such as nationalisation. The article says it is not clear how many contracts are stake. This market is famously opaque, but many people in the market are worried that the auction season that starts on Thursday is not going to go well. The defaults could imply huge losses for the insurers, or it could lead to disputed claims, thus undermining market confidence in this segment even further. This is the next crisis hot spot to watch out for.
Sarkozy to propose change in accounting rules
President Nicholas Sarkozy of France plans to propose a temporary change in accounting rules to give banks a breather during the market turmoil. (So instead of solving the problem, we are doing cosmetic surgery, by helping banks hide their losses from their shareholders). In particular, he wants changes to the mark-to-market rules, which have blamed for aggravating the crisis. The proposals are to be discussed at an emergency mini-summit this weekend in Paris, attended by France, Germany, Italy, plus the presidents of the European Commission and European Central Bank. The FT reports, however, that there are “scheduling” problems, which may mean that the summit may have to be delayed.
Germany gets tough on Hypo Shareholders
German finance minister Peer Steinbruck has told his party that shareholders in Hypo Real Estate will ultimately have to foot the bill, according to the Financial Times Deutschland. This was not immediately clear after the announcement of the de facto-bailout of the troubled bank. The federal government secured about two thirds of a €35bn private sector loan to the mortgage bank, which, if not repaid, would have to be born by Hypo shareholders first. In another article, the paper reports that Axel Weber made a dramatic appeal to Angela Merkel to accept the bail-out, on the grounds that a failure of Hypo Real Estate would have implied the total collapse of the EU interbanking market, and a collapse of the Pfandbrief – or covered bond – market. (Pfandbriefe are similar to mortgage-backed securities with the important difference that they are guaranteed by the issuing bank.)
European Parliament favours a single regulator
The head of the economic and monetary committee of the European Parliament favours a much stronger and more central banking regulator, in an interview with Financial Times Deutschland. Pervanche Beres criticises the lack of ambition on the part of Charly McCreevy, the EU Commissioner in charge of financial services. She wants the ECB to take this role. She also made the point that this would amount to a huge increase in the ECB’s powers, which would need to be compensated by a strengthen of the eurogroup of finance ministers. But she supports McCreevy with his new directive to force banks to retain some of the risk in any securitised products backed by loans they generate.
Will ECB cut as inflation falls?
The FT reports that euro area inflation fell from 3.8 to 3.6% in September, but the fall is not yet sufficient to persuade the ECB to cut interest rates yet. But there are clear signs that inflation may have passed its peak of 4%, and that it is now headed downwards. Consensus is now rate cuts now, but possibly in December or early next year.
Martin Wolf on the crisis
In an epic column, Martin Wolf argues that the US rescue is not good, but rejecting it is even worse, as there is no alternative in place, and as it signals that the US Congress may be tolerant of another depression. He says three things need to happen in the short run. Congress needs to pass the bill. Central banks must step up efforts to inject liquidity into the system, and Europeans should cuts interest rates now.
Just how bad is the European banking crisis?
Yves Smith at Naked Capitalism has an alarming entry this morning about the state of health of European banks, which are apparently even more wobbly and more highly geared than US banks, “as they were buyers of the dreckiest end of credit cycle CDOs and structured credits”. The finance industry looks increasingly like a house of cards. There is also an interest reference to the Infectious Greed blog (what a great name!), according to which the AIG bail-out also temporarily saved the European banking system, as AIG was apparently part of scam to help European banks “gaming” their regulators, by selling credit default swaps to European banks to present the illusion that the banks were adequately covered against some reckless risks on their balance sheets. This is also known as regulatory arbitrage.
Why the bailout package counter even counter-productive in the short run
In another entry, Naked Capitalism writes that in the short-term, any bailout package should fulfil three goals. 1. Prevent further bank runs; 2. revive the inter-banking market; 3. keep working capital loans rolling over to maintain solvency. The trouble with the bailout package is that it does not address any of these issues. The solutions for the three problems are respectively: 1. remove the deposit insurance cap. 2. pay banks interest on reserve, and merge the Fed funds and discount rates to allow the Fed to become a guarantor of the market, and 3. restore real bills discount lending (the real bills doctrine says that it is non-inflationary to issue money at a discount to commercial bills, since each of those bills represents a real transaction), and for the Federal Deposit Insurance Cooperation to resolve troubled banks directly.
Munchau on the policy implications
In his FT Deutschland column, Wolfgang Munchau says that the banking crisis requires a much more strategic policy response than what we have seen so far. Ad hoc rescues may work in isolated case, but not in a country like Germany with thousands of banks. What we need is a transparent strategic plan that would pass the Deutsche Bank-test – it should be able to handle the collapse of Germany’s largest financial institution. This would invariably have to be done at European level, as some of the largest financial institutions cannot be saved by the respective governments. He also says that Germany’s finance minister Peer Steinbruck is very unlikely to do any such thing, given his track record of a lack of interest in international affairs and European co-operation.
US house prices still in freefall
The US housing crash continues at immense speed. The Case Shiller price index (the composite 10 measure) was down 17.5% yoy in July, and 21.1% since the peak. If you look at those charts, it seems that those price are fast falling back towards the trend – they are still way above the trend still now – and there is some debate on whether price may overshoot the trend line. See the Calculated Risk blog for more.
Here is the latest Case-Shiller house price index:
and the year-on-year changes:
German unemployment falls and falls – despite recession
We know that employment lags growth, but the latest German unemployment numbers are the nevertheless surprising. In September, unemployment fell to a rat of 7.4% - the lowest in 16 years. This number is not seasonally adjusted. Frankfurter Allgemeine says that the total headcount could fall to below 3m. The Federal Labour Institute has not made any prediction for next year, but one labour research institute calculate that the total headcount would stagnate near 3.2m on the assumption of economic growth of 0.5%. That would be a significant improvement in comparison to previous economic downturns.
French unemployment rises and rises
In France, unemployment continues to rise, with 2.2% in August the highest increase since 1993. The rise affects all categories including seniors, juniors and long term unemployed. Le Monde writes that there are no quick fix policy measures the government has at its disposal on the contrary. Sarkozy’s policy to make extra working hours more attractive could backfire in the economic downturn now as companies will use internal sources instead of employing new. Meanwhile, Francois Fillon announced new social measures to calm down the spirits (such as extra Christmas premium for unemployed etc).
Coalition gambles in Austria
In Austria, amid massive losses of the two big parties and the rise of the two extreme right parties to the second largest political force, speculations about the next governing coalitions are running high. Socialist leader Werner Faymann told the press yesterday that he prefers another grand coalition and that a minority government is considered as the least desirable option. But the People’s Party is still busy with defining its new profile under Joseph Proll, the successor of Molterer, who quit after the disastrous results. The option of a coalition between People’s Party and the two far right parties is still out.
The staggering rise of the extreme right in the Austrian election on Sunday was seen by many commentators as a protest vote against the grand coalition, which frustrated voters during the two years of existence. Jean Quatremer instead argues that the real culprits are the Socialists, who moved into populist territory some time ago, most visible with respect to European policy. Socialists made Europe responsible for all the bad things (e.g. expensive euro) and joined forces with the far right to claim for a referendum on future Treaties to gain support from the influential Kronen Zeitung. Why should voters vote for a copy when they can have the original?
Do women pay higher interest rates in Italy?
Alberto Alesina has a fascinating piece in Vox, in which he asks the question why do women pay higher interest rates in Italy than men. As part of the study they wanted to test whether that result was also true in respect of banks run by woman, but alas there was no such bank in Italy, where is banking is an activity by men, and for men. They conclude that there is a possibility that women are being persistently discriminated against in the Italian banking system.
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