By Jason Simpkins
Central banks yesterday (Thursday) launched a coordinated effort to flood global money markets with U.S. dollars in hopes of easing strained financial systems in danger of freezing up entirely. However, many analysts see this as only a short-term solution that will lower overnight lending rates but fail to assist financial institutions with longer-term cash needs.
In a statement released at 3 a.m. yesterday morning in Washington, just as the markets opened in Europe, the U.S. Federal Reserve announced that it had authorized a $180 billion expansion of its swap credit lines, allowing banks to borrow more dollars at a lower rate. The Fed, Bank of Canada, European Central Bank, Bank of England, Swiss National Bank, and Bank of Japan increased their swap credit lines to $247 billion, nearly quadruple the current amount of $67 billion.
The European Central Bank increased its line to up to $110 billion from $55 billion. The Swiss National Bank increased its line from $12 billion to $27 billion. Lines with the Bank of Japan, Bank of England, and Bank of Canada were pumped up to $60 billion, $40 billion, and $10 billion respectively.
"These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets," the Fed said in a statement. "The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures."
The plan succeeded in reducing overnight dollar lending rates, as the London Interbank Offer Rate (LIBOR) dropped to 3.84% yesterday, down from 5.03% the day prior. The rate was just 2.15% last week, but spiked as high as 6.43% Tuesday. And the difference between the Libor rate and central bank policy rates remains substantial, which suggests banks are unwilling to lend to each other.
Yesterday's "coordinated intervention shows that the [central banks] are acting to address market liquidity failure – this is itself reassuring," Laurence Mutkin, head of European interest rate strategy at Morgan Stanley (MS) said in a research note. But, he added, "The intervention does not directly address the key problem… banks' desire to hoard cash and their reluctance to lend to each other."
The spreads between interbank lending rates and swap rates edged even higher yesterday, highlighting the prevalent concern about counterparty credit risk in the world's money markets.
, CNNMoney reported.
"We're back to where we were last summer when central banks managed to get overnight markets working but, for term markets to start working, counterparties need to start trusting each other and there's nothing they can really do about that," Ralf Preusser, head of European rates strategy at Deutsche Bank AG (DB) told CNN.
"At this stage, we need to see again who has what exposure to whom, what losses, what writedowns there are, whose business model survives and whose doesn't and who's left at the end," said Preusser.
Money Market Meltdown
The U.S. commercial paper market, integral to the functioning of major corporations, has also contracted significantly – further evidence of the lack of trust permeating the market, as well as a an indication of the precariousness of the U.S. financial system.
The commercial paper market fell $52.1 billion (2.9%) to a seasonally adjusted $1.76 trillion for the week ended Sept. 17 the Federal Reserve said yesterday. On a non-seasonally adjusted basis, the market dropped $74.1 billion (4.2%) to $1.68 trillion – the biggest percentage decline in a quarter-century.
"A continuation of this trend would be problematic for the economy, as the commercial paper market is where entities go to raise working capital to produce goods and services," Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. wrote in a note to clients.
Money-market funds have been devastated by the decline, as data from iMoneyNet shows that nearly $90 billion of net investor cash was pulled out of money-market funds on Wednesday.
The Reserve Primary Fund and the Reserve International Liquidity Fund Ltd. yesterday became the first money markets funds to "break the buck" since 1994, according to Bloomberg News. The Reserve Primary Fund lost more than 60% of its assets to redemption this week.
The Putnam Prime Money Market Fund saw such a severe run on its assets that it was forced into liquidation.
"Constraints on liquidity in money market instruments created the risk that in order to process redemptions, the fund would realize losses in selling its portfolio securities," Putnam said in a statement. "The Trustees determined to close the fund to ensure equitable treatment of all fund shareholders."
According to iMoneyNet, $130 billion left prime institutional money market funds Wednesday, after $61 billion of redemptions on Monday and $37.2 billion of redemptions on Tuesday.
News and Related Story Links:
- Wall Street Journal:
Defense Is Mounted for Shaken Markets
Money funds see record $90 billion one-day drop