Government plans bailout for banks, year end interbank spreads widening.

September 19, 2008

After taking over the GSE’s, and bailing out AIG over the week, the government has finally decided to purchase almost the entire load of bad debt on banks’ and other financial institutions’ balance sheets. It’s expected that one entity will buy up to around 800 billion of troubled paper from banks, while another 400 billion will be used to insure money market funds against a run. But a lot is unclear about the details yet.

 

To put this into perspective, Citigroup Inc., JPMorgan, Bank of America, Goldman Sachs , Merrill and Lehman alone had more than $500 billion of so-called Level 3 “illiquid, difficult to price” assets as of June 30, according to data in a Sept. 15 report from CreditSights Inc, Bloomberg reports. So it appears that, while significant, the amount of funds available through these entities will have to be increased at some point. Besides, it seems that the financial institutions will have to repurchase their assets in the future, that is, the new entity will be a giant long term repo facility. That would make this only an attempt an procrastination, rather than resolution. If there will be a bailout, the paper must be bought and held, without any expectation of redemption. The attempt at liquefying the bankinbg industry through Fed’s temporary facilities has clearly failed already, there’s no reason to think that a longer term facility will inspire the necessary confidence to fundamentally change the picture.

 

Nonetheless a brief period of general rally is possible now. Stock markets rallied through the hardest periods of last year, and interest rate reductions across the world, coupled with this temporary bailout of the financial sector may help to calm people for a while. But don’t be deluded by this development; year-end funding period is approaching, and right after the beginning of November, there’s every chance that we’ll see mayhem in the wider financial sector.  

 

Meanwhile, the yen interbank market has been shutdown for foreign borrowers. Japanese are in general very worried about lending anything at all to westerners, while among themselves they seem to be willing to trade on usual terms. Today the Bank of Japan pumped 2 trillion yen ($19.15 billion) into the money market for the fourth time as overnight call rate is above their 0.5 percent policy target.

 

“Lenders have become exceptionally conservative. Some foreign players are unlikely to get any money from the market,” a money dealer at a Japanese insurer reports via Reuters.

In Australia, the central bank added A$2.03 billion ($1.6 billion) in its regular market operation repurchase agreements, while draining A$1.0 billion through a same-day forex swap. Commercial banks’ balances with the central bank remain near a record A$6.97 billion. Libor-ois spread, the spread between three-month bank bill rates and three-month overnight index swap rates, surged to a record of 95 basis points, up from around 33 basis points at the start of the month in Australia.

In Europe, dollar overnight rates have stabilised since yesterday, however, three month spread on interbank dollar  was still quoted at a very high level, with offers(libor) at 4.25, and bids(depo rate) at 3,50 – up from 3,20 yesterday, while 2,15 is where they should be in normal times. The interpretation is that banks continue to expect dollar funding to remain extremely tight during the next few months, leading to year-end; and while central bank injections may ease the situation temporarily, there’s very little impact on the longer end of the yield curve. The situation is still tense.

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2 Responses to “Government plans bailout for banks, year end interbank spreads widening.”

  1. it’s hard to object to the government’s mass bailouts as similar debt-producing methods were put into action to bring the U.S. out of the Depression… our economy has been supported and driven by debt ever since

  2. moneymill said

    You should get your facts right, I’m afraid. The US did not get out of the recession through debt producing methods. The end came through the WWII. In fact, the US was in recession in 1937 through the greater part of 1938, and during that period unemployment was at levels close to 19 percent. Is 19 percent unemployment a success?At the peak in 1933 it was at 25 percent. Hitler used to compare his own record with that of Roosevelt to boast in those days.

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