Central Banks Coordinate to Inject Liquidity, First Time Since 9/11

Bloomberg reports on the coordinated effort by major and even some not-so-major central banks (Canada’s and Switzerland’s central banks are included) to tackle high interbank lending rates. One investor called it to “shock and awe,” which is a worrying comparison. In fact, the plan does not add net liquidity, but merely provides additional one-month term funding to get banks through a particularly acute year-end lending crunch (the Bank of England is also loosening collateral requirements for three month repos). Banks often restrict their operations in anticipation of year end, and banks have been withdrawing from the market earlier than usual this year.

While, as Reuters tells us, there is optimism that Libor will be fixed at a lower level tomorrow, and Libor had the monetary authorities particularly worried (while Treasuries had fallen, spreads over Treasuries have been unusually high, signaling reluctance to lend), some observers said these moves alone would not suffice. More transparency is needed to reassure investors, and that will take more time.

From Bloomberg:

The Federal Reserve, European Central Bank and three other central banks moved in concert to alleviate a credit squeeze threatening global growth, in the biggest act of international economic cooperation since the Sept. 11 terrorist attacks.

The Fed said in a statement it will make up to $24 billion available to the ECB and Swiss National Bank to increase the supply of dollars in Europe. The Fed also plans four auctions, including two this month that will add as much as $40 billion, to increase cash in the U.S…..

A Fed official told reporters that the U.S. central bank’s efforts won’t add net liquidity to the banking system. The plans are aimed at buttressing so-called term funding markets, such as for one-month loans, rather than overnight cash. The Fed will balance its various operations, including daily repurchases of Treasury notes and direct loans to banks.

The Bank of England increased the size of reserves it will auction in money market operations and widened the range of collateral it will accept on three-month loans….

“Ultimately the problems we’re facing go beyond illiquidity,” said Larry Hatheway, chief economist at UBS AG in London and a former researcher at the Fed “It’s another step in the healing process, but we have some way to go.”….

The measures are “designed to address elevated pressures in short-term funding markets,” the Fed said in a statement in Washington. The U.S. central bank said it’s considering setting up a permanent arrangement to provide funds to banks through so- called term auction facility operations.

“The interbank market isn’t working very well, and when the interbank market doesn’t work very well globally, this creates some problems,” Bank of Canada Governor David Dodge said in an interview today. “It’s part of our normal role as central banks to try to, if you will, unblock that.”….

“By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity,” the Fed statement said.

From Reuters (via the Guardian):
Finally, the world’s leading central banks may be gaining traction in their battle to free up liquidity in credit markets, restore c

onfidence in the global banking system and prevent slowing economic growth from, in some cases, spilling over into recession.

But the surprise package of measures announced by major central banks on Wednesday may not be enough on its own to completely fully thaw the credit market freeze and further policy easing — not to mention patience — may be required.
For example, it will take time for banks to confidently lend to counterparties still thought to be saddled with debt-related losses, months of tight credit still has to work its way through the economy and prolonged financial market stress simply won’t be waved away with a magic wand overnight.

Still, the measures which include the creation of a short-term lending facility from the Federal Reserve and a $24 billion currency swap facility between the Fed, European Central Bank and Swiss National Bank, should help ease year-end funding tensions. “This will certainly help alleviate the liquidity squeeze but the main problem is still persuading banks to make liquidity go around, not just sit on it,” said Marco Annunziata, chief economist and global head of fixed income research at UniCredit Markets & Investment Banking.

“For this we also need more transparency on the write-offs and losses, which i think we will get in the next few months. So I do think this is a very important and positive step, but you will also need more clarity to see liquidity conditions normalize in asset markets,” he said.

Banks around the world have racked up losses and debt-related writedowns stemming form the collapse of the U.S. subprime mortgage market of more than $60 billion in recent months.

Immediately after the package was unveiled, indicated money market rates for dollar, euro and sterling deposits across the one-three month spectrum fell, suggesting Thursday’s daily London interbank offered rates (Libor) will be fixed lower.

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  1. HowardR.


    What the FED is doing is taking toxic junk paper that can not be valued and is rated tier 3 and will except what the bank says it is worth or very close to what the banks says. This will allow the bank not have to report and write down, as they will use the FED acceptance price as the market price. The banks do not have to turn over all of the toxic waste,but only enough to establish a price. The FED price will be used by the auditors and effectely hide the losss that should be reported. Since the transaction will be not disclosed by the FED, you will not know if the bank has losses that are now hidden from the public. I hope that I am wrong but it appears that the FED is now helping the banks to hide their losses. Part of the FED’s statement is that it is considering continuing tis auction beyond Jan. 2008. So it could be a long time before the truth is known

  2. HowardR.

    Taken from Graf
    Merrill put out a piece this afternoon about the “Term Auction Facility” with this interesting link to the FRB


    If I’ve read the schedule correctly the “successful bidders” will be able to lodge toxic waste ABS as “collateral” for these loans. Triple A rated ABs, without verifiable market values, will receive 85 cents on the dollar. “Non AAA” ABS will receive 80 cents loan value on the dollar. This is many times what the ABX indices say this junk is worth.

    Question. Is anyone aware of a bank failing to take back, i.e. re-purchase, securities they have lodged with the Fed? What a neat way of getting rid of your stuff that’s maybe worth 25-35 cents on the dollar for 80 cents, just by pledging it as collateral and then failing to take it back at the expiry of the loan. A bailout in disguise???

    Written by Giraf on 2007-12-12 18:20:08

  3. Anonymous

    if a bailout on one side, a ‘bail in’ on the other.
    such internalization might cause stomach

  4. vlade

    Fed does repos, and repos are legally binding sale and re-purchase agreements (on a price that has been agreed up-front).

    The only way to weasel out that one would be bankrupcy.

    I think Fed’s betting that taking a risk some of the cpties will default is better than if they would default because of the LIBORs being at base+100bp.

    Similarly, I’m not sure whether the rate they can repo them with Fed will have any impact on their accounting. Even though legally repos are change of legal ownership, from the accounting perspective the ownership stays (so, the junk stays on the bank’s balance sheet).
    Moreover, since the price is pre-agreed (and has no relation to market price), I think it would be a brave bank that would try to use that to value it on their sheets.
    Also, note that since the final price is pre-agreed it doesn’t matter if half of the martgages making up the bond defaulted while Fed was holding it, as the cpty has to (subject to it still being able to) pay the full amount they agreed on initially.

    In effect, what Fed’s doing here is doing a sort of an usecured loan (which it cannot, under normal circumstances), but pretending for it to be a repo.

    That, in my opinion, is the only way how to insert (real) liquidity in the market and in a way this seems a rather neat solution. It’s risky to taxpayers, granted, but then, any solution would be.
    It’s better than printing money – as long as the repos won’t roll forever and ever, and would eventually have to be repaid.

    This is the danger of the scheme I see – that the take up will be so strong that FEd will not be able to wean the market off it.

    BTW, attempts to do similar transactions started to crop up in the market (as large junk-repos, or TRS + buying the asset hedge from the same cpty), but the appetite just wasn’t there, even with rather nice spreads.

  5. foesskewered


    wouldn’t that just prove that it’s a delaying/postponement measure whilst hoping the broader market would bounce back and be willing to be the owners of these toxic instruments?

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