Page 3 of 5 US government throws oil on fire
By Henry C K Liu
"The short-term debt markets have been under considerable stress in recent
weeks as money market mutual funds and other investors have had difficulty
selling assets to satisfy redemption requests and meet portfolio rebalancing
needs," the Fed said.
Under the Fed scheme, the US central bank will lend money to five special
purpose vehicles, to be managed by JPMorgan Chase, tasked with purchasing
assets from money market funds. These assets are low-risk paper, including
certificates of deposit, bank notes and commercial paper with three-month
maturities or less.
The creation of an extra liquidity facility on October 21 was seen as
complementing a move the Fed announced two weeks earlier
to create a vehicle aimed at purchasing potentially unlimited amounts of
three-month debt from banks and non-financial companies. The size of the Fed's
balance sheet has nearly doubled.
Each of the five vehicles may purchase paper from 10 financial institutions.
The overall size of the program is capped at $600 billion - with the Fed
funding 90% and the funds, which sell assets, taking the first 10% of losses.
The Fed announced its plan even as money markets showed signs of easing.
Overnight dollar Libor (London Interbank Offered Rate) declined 23 basis points
to 1.28%, below the Fed's target rate of 1.5%. Three-month dollar Libor eased
to 3.83%, its lowest fix in nearly a month. Three-month Libor was fixing about
2.80% prior to upheavals and has yet to reflect the Fed's rate cut on October 8
of 50 basis points.
Strategy ignores asset overvaluation
Although each step by the government in reaction to the credit crisis was a
logical, targeted response to new systemic financial upheavals, the result was
to prop up select distressed firms deemed too big to fail and support failing
markets as they occurred, hoping in vain that it would be the last move needed
to resolve the systemic crisis to put the economy on a path of recovery. The
Fed and the Treasury appeared to be rushing from emergency to emergency without
a strategic plan to deal with the fundamental problem of a debt bubble
collapse.
The disjointed interventions appeared designed to keep a collapsing debt bubble
from collapsing, a hopeless task that even former Fed chairman Alan Greenspan,
the bubble wizard par excellence, was not naive enough to try. Greenspan merely
replaced a burst bubble with a new bigger bubble, never trying to stop a
collapsing bubble in mid course. Greenspan's approach was that of a
post-disaster cleanup crew, not rushing into a collapsing structure as the
current bailout team appears to be trying to do. Throwing good money after bad
merely makes good money into bad. Spending good money after the collapse would
infinitely buy more in the cleanup task.
Added to the mix was the political problem of government credit allocation. In
April, Chris Dodd, chairman of the Senate Banking Committee, demanded that the
Fed permit top-rated securities backed by student loans that now had uncertain
market value and anemic liquidity to qualify for its $200 billion swap program.
"If the Fed and the Treasury can commit $30 billion of taxpayer money to enable
the takeover of Bear Stearns by JPMorgan Chase, then surely they can step in to
enable working families to achieve the dream of a higher education for their
children," the senator declared.
Two weeks later, the Fed said it would accept any AAA-rated securities as
collateral, including those backed by student loans. The Fed has forced to move
from its traditional role of neutral macro policy of stabilization to direct
specific credit allocation, albeit in this particular case for a worthy cause,
for where is the logic of saving the banking system to save tax payers' homes
and not save the education of the nation's youths. As a matter of national
policy, all education should be financed by public funds since education is the
most rewarding social investment a society can make. Another is universal
health care.
The economies of New York and New Jersey are also now severely impacted by the
financial crisis on Wall Street. These states normally derive up to 30% of
their revenue from the financial sector. The governors of the two states are
calling for further stimulative aid from Washington. California is also saying
it needs low-interest loans from the federal government to help with its
budgetary shortfalls. The problem will spread to all states as the problems in
financial sector spread to the economy.
The Fed floods Europe with dollars
On Monday, October 13, the Federal Reserve opened up the dollar spigot to
European central banks to support the European dollar credit markets by
agreeing to provide unlimited dollars, up from its previous $620 billion in
currency swaps, to the three major central banks: the European Central Bank,
the Bank of England and the Swiss National Bank, to allow them to relieve
liquidity pressure on commercial banks across their respective regions.
Dollars had become elusive in recent weeks in the European banking system as
short-term money markets around the world deteriorated. Domestic and foreign
banks in Europe had been frozen out of loans beyond a day as institutions
hoarded dollar resources amid concerns about counterparty default. Around the
world, central banks were forced to move from the traditional role of monetary
rule-makers to that of money and currency market players.
Meanwhile, to offer vastly more operational space to expand its liquidity
facilities during the credit crisis, the Fed received authority from the
Treasury in early October to start paying interest on reserves that commercial
banks are required to deposit at the Fed.
Prompted by the US, governments across Europe took action to bail out their
respective banks and protect their separate banking systems after the meeting
of the Group of Seven leading industrialized countries in Washington during the
weekend of October 11.
France extended state guarantees to $435 billion of senior bank debt to help
jumpstart that country's credit markets. It created a state company with up to
$54 billion in capital to recapitalize distressed French banks. The UK
guaranteed $434 billion of bank debts and injected $64 billion into Royal Bank
of Scotland Group, HBOS, a banking/insurance group in the UK, and Lloyds TSB
Group, as part of its already announced ฃ400 billion (US$651 billion)
bail-out plan.
Germany guaranteed up to $544 billion inter-bank debts, setting aside $27
billion for potential losses and injected up to $109 billion equity in German
banks. Italy announced it will recapitalize Italian banks and guarantee bonds
on a case-by-case basis. Spain will guarantee $136 billion in Spanish bank
debts, set up a preventive facility to inject new capital into distressed
Spanish banks until 2009 and establish up to $68 billion to buy Spanish bank
assets.
The Netherlands is injecting 10 billion euros (US$13.4 billion) into ING Group,
the banking and insurance giant which just weeks earlier was the white knight
to bail out troubled Fortis. Austria, Portugal and Norway joined the effort,
committing a total of 501 billion euros in guarantees and capital for banks in
their respective jurisdiction.
Iceland banking crisis and geopolitics
Iceland's banking system meanwhile collapsed in September causing losses to
non-Icelandic European depositors who were attracted by higher interest rates
paid by Icelandic banks. The tiny country over the past decade had embraced
neoliberal free-market capitalism and built a financial sector that brought
unprecedented but unsustainable prosperity to its 300,000 people and won
temporary favor with foreign savers and investors.
Iceland's financial crisis cannot be solved by bank nationalization, currency
de-pegging and stock market suspension because its central bank, unlike the US
Federal Reserve, which can produce dollars at will, must either earn or borrow
euros and dollars. Failing to access International Monetary Fund loans because
it is not yet part of the EU, Iceland turned to Russia for help. Commenting on
the possibility of a 4 billion euro loan from Russia, Icelandic journalist Omar
Valdimarsson ridiculed the value of 50 years of "special relationship" with the
US by quoting Deng Xiaoping's famous saying: "It does not matter if the cat is
black or white as long as it catches mice." The fat cat is Russia, although at
the time of writing agreement with Moscow had yet to be reached.
Various reports, including in Business Week, on October 21 indicated Iceland
"was likely" to receive a $6 billion rescue package "tailored by the
International Monetary Fund (IMF), Nordic countries and Japan".
Crisis in East European banks
Banks in emerging economies in post-communist Eastern Europe, such as Hungary
and Ukraine, were also hard hit. Ukraine, whose economy has been badly hurt
from falling steel prices, may be unable to quickly accept a loan offered by
the International Monetary Fund because the fund is seeking assurances on next
year's budget from the cabinet, and the cabinet was recently dissolved by the
president in a political shakeup.
While, with Iceland and Hungary, one of three European nations seeking aid from
the IMF, Ukraine has complex political problems, being a country of 46 million
culturally and politically divided between historical affinity towards Russia
and new orientation towards the West.
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
