Overnight dollar squeeze posing systemic risk, bankruptcy fears mount

September 17, 2008

There’s extreme worry about the tightness in overnight funding. Interbank dollar funding is tight across the world, from Asia, to Europe, to US. While spreads have eased somewhat today,  there’s still an undeniable need for further injections. With 235 billion in total over the past two days, central banks may not be so willing to add the vast sums needed.  They must, however, because the situation is dire. And the hope and expectation is that they will act soon.

overnight libor-16th September

overnight libor-16th September

Look at the spike; that’s for 16th September. The TED spread today has reached the highest levels since Black Monday of 1987.

The fear is that the lack of will for short term funding will cause cash squeeze for banks and other financial institutions; overnight rates are around 5-6 percent, more than twice the Fed’s target. This is by far the most important problem for financial markets right now, as short term rates have only responded slightly to massive liquidity pumping recently.

This is the kind of situation that used to occur in the developing and thirld world, in places such as Argentina, Turkey, during past financial crises. There’s no question that the market is clearly and unmistakably worried about the system’s stability, and unless some way is found to ease the short term, a cascade of bankruptcies is possible.

With Reserve Primary Fund breaking the buck, and Lehman paper promising more failures, there has been a general flight from money market funds, and as they create a lot of the liquidity in short term money markets, there’s an incredible shortage of cash everywhere.

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