We noted earlier today that neither the signing of the much-touted bailout bill, nor the dramatic increase in size of the already bulked-up Term Auction Facility (it has been enlarged six-fold in a mere two weeks) has had any impact on conditions the money markets, which are barely functioning. We noted earlier and reiterated that the Fed’s latest liquidity moves have in fact been counterproductive, reinforcing the propensity of banks to rely on central banks rather than each other. We also affirmed a notion voiced by John Jansen, that the Fed and other central banks need to guarantee commercial paper and interbank loans, rather than continue to engage in indirect measures that have proven useless.
The general mood is reflected in the stock markets, where the Dow took a dive to 700 points down, although (as of this wriiting) it had rebounded to a mere just shy of 500 points in negative territory, but has resumed its downward path, now 551 points down. One spur for the depth of the move was normally relentless bull Jim Cramer’s advice pre-opening, on the Today Show, that, “Whatever money you may need for the next five years, please take it out of the stock market right now, this week.” The yen has rallied nearly 4% in a mere week, another sign of an accelerated retreat from risk. Brent crude is below $85 and gold has rise $36 per ounce so far today. (Update: reader Dwight pinged that the stock market staged a monster recovery immediately before the close, from a low of just over 9500 to 10,000. What gives? The trigger may have been the request by France for an emergency G8 meeting, but no one has even agreed!]
Nouriel Roubini has weighed in even more forcefully on these issues in “The Fed keeps on wasting time while the mother of all bank runs is underway” (hat tip reader Dwight).
Last Friday I pointed out in my “Financial and Corporate System is in Cardiac Arrest: The Risk of the Mother of All Bank Runs” that we were at the point of a risk of a systemic financial meltdown with the beginning of the mother of all bank runs: stock markets gave a vote of no confidence to the Senate passage of the TARP legislation (equities down 4% on Thursday) and to the House passage of the legislation on Friday (equities down 3% after the passage of the bill in the House). At the same time last week money markets, interbank markets, credit markets were all imploding with all interbank spread at new all time highs, credit spreads going up through the roof and the roll-off of the financing – via commercial paper – of the corporate system. As I put it last week we were facing:
- a silent run on the huge mass of uninsured deposits of the banking system and even a run on some insured deposits are small depositors are scared;
- a run on most of the shadow banking system: over 300 non bank mortgage lenders are now bust; the SIVs and conduits are now all bust; the five major brokers dealers are now bust (Bear and Lehman) or still under severe stress even after they have been converted into banks (Merrill, Morgan, Goldman); a run on money market funds restrained only by a blanket government guarantee; a serious run on hedge funds; a looming refinancing crisis for private equity firms and LBOs);
- a run on the short term liabilities of the corporate sector as the commercial paper market has totally frozen (and experiencing a roll-off) while access to medium terms and long term financings for corporations is frozen at a time when hundreds of billions of dollars of maturing debts need to be rolled over;
- a total seizure of the interbank and money markets.
This is indeed a cardiac arrest for the shadow and non-shadow banking system and for the system of financing of the corporate sector. The shutdown of financing for the corporate system is particularly scary: solvent but illiquid corporations that cannot roll over their maturing debt may now face massive defaults due to this illiquidity. And if the financing of the corporate sectors shuts down and remains shut down the risk of an economic collapse similar to the Great Depression becomes highly likely….
I then suggested that only radical and urgent action could stop this mother of all runs such as the following ones:
- blanket guarantees of all deposits followed by triage between solvent and insolvent banks; and if a guarantee requires delayed legislative action the Fed could announce that it will provide unlimited and unconditional liquidity support to any bank that experiences a run on its uninsured deposits;
- drect extension of the Fed’s PDCF liquidity support to other member of the shadow banking system as the small number of broker dealers accessing the PDCF are not relending the liquidity to the rest of the shadow banking system; finance companies, leasing companies and other non-bank financial institutions lending to the corporate sector and real economy should have access to the PDCF and TSLF;
- drect Fed lending to the corporate sector via Fed buying the commercial paper that corporates are not able to roll over; and possibly even lending to state and local governments that are a now also facing a roll-off of their maturing short-term liabilities.
- a coordinated 100bps reduction in policy rates by all major advanced economies central bank and, possibly, even some emerging market economies central banks;
Since the crisis of confidence and liquidity was becoming more virulent over the last few days and during the weekend in Europe one would have expected a radical response over the weekend…
Instead the Fed did nothing over the weekend (before the crucial opening of markets in Asia and Europe) and then announced steps this morning that don’t even start to address the liquidity problems of the financial system: paying interest on reserves of banks only allows the Fed to provide more liquidity to banks (and only banks) while automatically sterilizing the effects of that liquidity support on base money; while doubling the size of the TAF (that only banks have access to) does nothing to address the run on the liquid liabilities of non-bank and the corporate sector. Also the liquidity support of banks (short of a formal guarantee of deposits and/or a commitment to unconditionally support any bank subject to a run) is not enough to stop the concerns by uninsured depositors of banks….
Given the risk of insolvency of even the most safe counterparties in the financial and corporate system reducing policy rates will not affect interbank and credit spreads. The only way to stop this liquidity panic is a blanket guarantee of financial sector liabilities and direct public provision of liquidity to the parts of the financial system and the corporate system that are now at risk of a meltdown driven by a liquidity run on their short term liabilities. So it is time for the Fed to stop wasting time and start the actions that will make a difference. We are now at risk of a systemic financial meltdown of the financial system and the corporate sector too.