The money markets on the verge of a nervous breakdown
Hank Paulson apparently went down on his knees in front of Nancy Pelosi to beg her to accept his rescue plan. But there was no deal yesterday. Read the FT, or any other newspaper, for further tedious details on the goings on at Capitol Hill and the White House yesterday. Global stock markets had a good day yesterday, with European stocks up some 2%, but the big news yesterday was the convulsion in the global money markets, which according to one analyst is about a minute from a fatal heart attack. Money markets rate shot up yesterday, and spreads widened to historic levels. Oh, and by the way, another American bank failed yesterday, Washington Mutual, America’s sixth largest, and the country’s largest mutual savings banks. Its remnants were bought up by JPMorgan Chase.
The money markets on the verge of a nervous breakdown
The money market, not the stock market, is where this financial crisis is playing out first and foremost. On this market, banks lend each others funds for short periods of time with no collateral. A favourite way to measure distress in the way money is the difference between the interest rate on 3-month Treasury – which are considered safe – and 3-month Libor. This is known as the TED spread. If you consider your counterparty bank safe, you would expect to receive only a slightly higher interest rate on 3 Libor than you would on 3 month treasuries. But if you expect to receive more than 300 basis points, as banks do now, then you doubt the financial viability of your counterparty. Yesterday, the spread briefly peaked at 333bp, which must be an all-time record. Frankfurter Allgemeine reports that the complete drying-up of short-term liquidity might even force global central banks into co-ordinated action to cut interest rates.
Here is a chart of the latest TED spread.
Another slightly different way to look at money market distress is the Libor-OIS spread, which stands for overnight index swap rate. This is the favourite measure used by the Fed, as it measures what traders expect the Fed funds rate to be. Bloomberg reports that the 3-month Libor-OIS spread the Libor-OIS spread widened today by 32bp to almost 200bp, the highest ever. It averaged 8bp in the 12 months before the crisis.
The FT reports that commercial paper from the Fed showed a fall of $61bn last week, the biggest since the crisis started. And three month dollar Libor was up 29bp at 3.77%. 3-month euro libor also reached a record of 5.11%, and for sterling it hit 6.27%.
The question this morning is: what will the money markets do, if there is no deal today?
Opposition to the Pauslon plan
During the week, opposition to this plan has intensified. Yesterday, Republicans came up with an alternative plan, which included a much smaller role for government. The Naked Capitalism blog reports a speech by Fed governor Richard Fisher, head of the Texas Fed, and the most persistent hawk on its policy setting committee, who publically voiced concerned about the plan, which is he said was too expensive. In his speech, he also makes the point that cutting interest rates is not going to alleviate any pressure, and is only going
Germany plans draconian financial regulation
The German finance minister Peer Steinbruck yesterday outlined a series of Draconian financial regulation proposals which, if adopted, would throw Germany back into the financial dark ages. Frankfurter Allgemeine reports that he wants to make short selling illegal (we don’t get it: if you think short-selling is wrong during downturn, then surely you must ban “long” buying during upturns. So why is he not proposing that? If you only ban short-selling, you may even make asset bubbles worse!) Furthermore, he wants to impose
unilateral legislation force banks to take on 20% of the credit risk, when selling on a bundle of credits to third parties for the purpose of securisation. The European Commission is also drafting legislation to force banks to retain some 10% of the credit risk. The reaction was predictably devastating. Jan Pieter Krahan, professor of finance in Frankfurt, is quoted as saying that this was precisely the regulation we do not need, as the right level of risk sharing cannot be determined global, but depends on the type of securitisation. Depending on how the package is construed, 20% can be either too little or too much.
The FT reported that Steinbruck, speaking in the Bundestag, also put criticised the Americans for being arrogant, having continuously rejected Germany’s proposals for better financial regulation. He also predicted that the Americans will lose their superpower status, and the dollar’s strength as a global reserve currency will become relative. This is the ultimately “I told you so” story.
Papademous warns about continued inflation risks
So if you think that the ECB is about to cut interest rates, you should perhaps listen to Lucas Papademous, vice president of the ECB, who told Il sole 24 ore in an interview that the medium-term outlook of inflation is mostly influenced by price pressures in the labour market, and the current outlook is not very encouraging as nominal wages are increasing faster and productivity rates are falling. During the three quarters Q4(2007), Q1,Q2(2008) unit labour costs rose 2.8%, compared to an increase of 1.5% during the previous three quarters. He also said the crisis would hit the euro area economy hard and for longer than previously expected.
Sarkozy says current institutions ill-equipped to deal with crisis
The FT reports on a speech given by Nicolas Sarkozy in Toulon, in which he said, among others, that the crisis highly deficiencies in the EU’s institutional arrangements, and said that the EU would not be in a position to deal as swiftly with the crisis as the US would. He also made the same point about the Bretton Woods institutions, saying that we cannot manage the 21st century economy with 20th century institutions.
We need a global monetary authority
As we go through this crisis, the commentary has been getting more extreme. Jeffrey Garten, writing in the FT, said the IMF and the G7 have both proved irrelevant to the crisis, yet this crisis is truly global. The growth of global assets far outstrips the growth of global GDP, and most of the large financial companies operate worldwide. He advocates a global monetary authority, by which he does not mean a central bank, but a global capital markets regulator that would also act as a bankruptcy court.
Ireland now “officially” in recession
In the end, it probably does not matter a great deal who is first to enter into recession, but rather who is going to be first to come out of it. But what it is worth, that trophy goes to Ireland, which yesterday reported a second consecutive quarter of falling economic growth. GDP contracted by 0.5% in Q3, after 0.3% in Q2. The Irish Independent reports that this is the first contraction since 1983 – 25 years!
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