“Not only is there no God,” said Woody Allen, “but try getting a plumber on weekends.” That just about sums up the problems of today’s financial markets. The plumbing is badly blocked, and nobody seems able to fix it, not even the central banks, the market’s immortals.
The problem is the apparent reluctance of banks to lend to each other, particularly over three months. That problem arises, in part, from uncertainty about who will pay the bill for America’s subprime-mortgage collapse. But it also results from the need for banks to protect their own balance-sheets in the face of some unexpected claims on their capital.
The result is that banks are paying much more to borrow than normal, particularly compared with governments. According to Goldman Sachs, one measure of this gap between American Treasury bills and interbank rates, nicknamed the “Ted spread,” is at a 20-year high. And like other plumbing problems, this could have severe consequences, because when banks pay more to borrow they pass the cost on to consumers and companies.
On September 5th the Bank of England got its monkey wrench out and tackled one issue, the half-percentage-point gap between overnight lending rates and its official benchmark. The Bank promised to lend more money to the market, if necessary, to bring overnight rates down.
Critics argue that the Bank has been time-wasting. The European Central Bank and the Federal Reserve made similar moves last month, and the ECB did so again on September 6th. But the Bank of England’s failure to act sooner seems to be part of a general reluctance to be seen to be saving speculators from their mistakes. The Bank made it clear that it was not aiming to bring down three-month lending rates, which are the markets’ most acute pressure point. A bank may be good for its money in the morning, but who knows what will have happened by December?
Perhaps central banks cannot solve the problem on their own anyway. They have offered to provide finance to any bank that needs it via mechanisms such as the discount window operated by the Federal Reserve. But banks are understandably reluctant to show any hint of desperation. Borrowing from a central bank in the middle of a liquidity crisis is rather like a schoolboy agreeing to have a sign saying “Kick me” pinned to his shirt-tails.
Even a cut in official rates, as is expected in America later this month, may not clear the blockage. The fundamental problem is that the banks made promises that they did not expect to have to keep. These “contingent liabilities” require banks to take the strain when their clients face problems in finding funding elsewhere. Suddenly, a lot of these bills have come due at once.
According to Dealogic, more than $380 billion of loans and bonds linked to pending leveraged buy-outs need to be shifted now that Wall Street bankers have returned from their holidays. The speed of the market deterioration has been a big part of the problem. Banks made short-term or bridge loans to private-equity buyers with a typical 30-60 day holding period. When the markets were buzzing earlier this year, they assumed nothing could go wrong in such a short time. But they were wrong, and now they face the prospect of having to keep large chunks of the debt on their own books indefinitely, marked at a loss.