Write-downs of $45 billion, and billions more to come. A collapse in share prices that has destroyed even more value. The blood of two Wall Street chieftains and many more underlings on the carpet. The fallout from the credit crunch has been so intense that some feel a pain barrier may have been breached. On November 27th and 28th the S&P 500 posted its first consecutive daily gains since October, partly on hopes of a cut in American interest rates and on some rare good news about Citigroup. But four months after they first seized up, the credit markets remain in a state of paralysis. The banks still have a long, hard slog ahead.
Short-term interbank rates at which banks lend to each other, and which are a good gauge of concern, have risen steadily since mid-November. On November 28th the two-month London Interbank-Offered Rate hit its highest level in euros since May 2001. Rates in euros and dollars tower obdurately above central-bank targets, despite announcements from both the European Central Bank and America’s Federal Reserve that they will inject extra funds into the money markets.
As in the summer, banks are hoarding cash because there is still great uncertainty about their own and counterparties’ exposure to losses and off-balance-sheet vehicles. Groups of banks that know each other well, such as the Spanish and Scandinavian banks, are rumored to have agreed on informal lending arrangements. Elsewhere, caution prevails: what interbank lending there is tends to happen in the afternoon, after all the bad news has had time to come out.
There’s still plenty of that to go round. Kreditanstalt für Wiederaufbau, a state-owned German bank, announced on November 27th that it was setting aside another €2.3 billion ($3.4 billion) to cover subprime-related losses at IKB, a Dusseldorf-based bank in which it has a large stake. On the same day, Wells Fargo, an American bank that had been looking pristine in comparison with its peers, revealed that it would take a $1.4 billion charge on its home-equity loans.
Nerves have frayed in even the sleepiest corners. Europe’s covered-bond specialists emerged blinking into the light after a spike in spreads and the postponement of several new issues led to the temporary suspension of the market in late November. By most measures, covered bonds are the safest of bets. The assets that back them (either pools of mortgages or public-sector loans) are required to meet stringent quality standards. If things do go wrong, investors have recourse both to the assets that back them and to issuers’ balance sheets. Yet even these belts and braces did not reassure investors.
Liquidity problems are compounded by impending calendar and fiscal year-ends. Banks are keen to hold cash when markets are closed or trading is thin. Many are also cleaning up their books for accounting purposes. Some of the central-bank interventions are geared to getting banks over the year-end squeeze: the Fed has extended $8 billion in short-term loans until early 2008.
Year-end fretfulness has prompted some comparisons with the turn of the millennium, when fears of the “Y2K bug” also encouraged the stockpiling of cash. But the analogy ends there: although funding conditions should ease in January, few believe that the credit markets are going to spring back to normal. Valuation methodologies and disclosure standards on toxic investments still vary widely. The market value of subprime assets continues to move around. Question marks over the wider economy are intensifying—on November 28th Don Kohn, the Fed’s vice-chairman, sparked hopes of another interest-rate cut in December when he acknowledged the impact of “elevated turbulence” in financial markets on the availability of credit.
Off-balance-sheet assets are another source of worry. On November 26th HSBC, Europe’s biggest bank, announced that it would consolidate $45 billion-worth of assets held in two structured investment vehicles (SIVs) onto its balance sheet. That puts pressure on other banks with exposure to SIVs, troubled Citigroup chief among them, to follow suit. It also shows that HSBC does not believe funding conditions for SIVs will soon ease.
A prolonged period of tight liquidity is arguably more threatening to banks than one-off write-downs, particularly for those that rely on wholesale funding. Expect to see slower loan growth, more asset sales and a fight for deposits, as banks try to diversify their sources of funding. Vasco Moreno of Keefe, Bruyette & Woods, an investment bank, thinks it will take a year of banks reporting decent numbers before an end can be called to the credit crunch. Roll on 2009.