Apologies for the heavy reliance on the Financial Times today, but the pickings elsewhere are meager indeed.
The FT has an interesting juxtaposition of stores on its website tonight. The lead story, from the Fed’s Jackson Hole conference, reports that Bundesbank President Axel Weber described the current credit crunch as resembling a bank run, but involving non-bank actors. However, central bankers cannot address this problem directly and may have to resort to easing monetary policy instead:
The current turmoil in the financial markets has all the characteristics of a classic banking crisis, but one that is taking place outside the traditional banking sector, Axel Weber, president of the Bundesbank, said….
The comments mark the first time that a top central banker has endorsed the notion that the non-bank financial system is seeing an old-style bank run….
The Bundesbank president said that the market had completely over-reacted to the credit losses in the US subprime mortgage sector….
However, the tools that modern central banks possess to address liquidity problems can only directly address such runs inside the traditional banking sector, and do not directly touch the non-bank financial sector, which has been hardest hit by the current credit crisis.
Mr Weber’s analysis highlights the dilemma facing central banks, which cannot channel funds directly to the non-bank financial sector, and may therefore have to resort to easing monetary policy instead. The ECB is due to set its key interest rate on Thursday and the Federal Reserve on September 18.
Mr Weber told fellow central bankers and economists at the Federal Reserve’s Jackson Hole symposium that the only difference between a classic banking crisis and the turmoil under way in the markets is that the institutions most affected at the moment are conduits and investment vehicles raising funds in the commercial bond market, rather than regulated banks.
These entities were inherently vulnerable to a sudden loss of confidence on the part of their funders because “there is a maturity mismatch” on the part of financial institutions that have invested in long term mortgage-backed or asset-backed securities using short-term finance.
“Most of the conduits are owned by the banks,” he said. In many cases, sponsoring banks are being forced to take risky assets back onto their balance sheets, in turn causing banks to keep hold of their own cash, putting pressure on short-term money markets, he argued.
While the Bundesbank chief and others at the Fed conference saw a “run on the shadow banking system,” the White House cheerily maintained that things would sort themselves out on their own:
The private sector will find ways to structure debt arrangements that will ensure that most US homeowners facing big increases in their mortgage payments will stay in their homes, Ed Lazear, chairman of the White House council of economic advisers has told the Financial Times.
Mr Lazear said the administration did not believe it would be helpful to set up a government-sponsored vehicle to organise debt arrangements, which involve rescheduling or reducing payments by the borrower.
“I believe, and I think the president believes, that markets are very good at finding ways to solve problems,” he said.
Now admittedly, Weber and Lazear are addressing distinct but intertwined issues. The central bankers at Jackson Hole are discussing a global deleveraging that was set off by the US subprime crisis; Lazear is speaking more narrowly about the the subprime crisis as it affects US homeowners, and perhaps the broader US economy. And one could also argue that, since the markets are irrationally panicked, reassurance, even if it is a bit empty, is a good thing.
But the specter of the Administration hailing the virtues of the markets when those very same markets got us into this mess is an act of willful blindness. However this “do as little as possible” posture is consistent with President’s choice to announce his largely cosmetic housing program on the deadest Friday of the summer.