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Money-Market Rates Climb to Records, BOE Relaxes Funding Rules

Bloomberg  / October 3, 2008 15:15 EDT

By Justin Carrigan and John Fraher

Oct. 3 (Bloomberg) — Money-market rates jumped to records, Treasury bill rates fell and the Bank of England relaxed borrowing rules for financial institutions as “extraordinary” strains deepened the credit freeze.

The London interbank offered rate, or Libor, that banks charge each other for three-month loans in euros increased to 5.33 percent, an all-time high, the British Bankers’ Association said. The corresponding rate for dollars climbed to 4.33 percent, the highest since January. The Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record and Asian bank rates climbed to the highest levels in at least nine months.

“It feels like the financial-sector problems are snowballing, developing momentum that will be hard to stop,” said Greg Gibbs, director of currency strategy at ABN Amro Holding NV in Sydney. “The further deterioration in term bank- funding costs and spread widening even as policy makers in the U.S. are poised to pass a rescue bill is worrying.”

Central banks are stepping up efforts to revive lending by pumping money into the financial system. The U.S. House of Representatives will consider a package of measures today that would remove tainted assets from bank balance sheets.

“In these extraordinary market conditions, the Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity,” Governor Mervyn King said in a statement in London today.

The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, climbed 20 basis points to 290 basis points today. It’s the third consecutive day the spread has risen to an all-time high. The average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.

Cash Auctions

The Bank of England will widen the range of collateral it accepts at three-month operations to make it easier for banks in the U.K. to get funds. The central bank said it will now accept top-rated securities tied to “some” corporate and consumer loans as well as asset-backed commercial paper with the highest short-term ratings.

“It’s another thing that shows how serious the situation is,” said Grant Lewis, an economist at Daiwa Securities SMBC Europe Ltd. in London. “Of the central banks, it’s been perhaps the most resistant to providing help.”

The Bank of England also offered $30 billion of one-week funds and $10 billion in overnight loans. The European Central Bank, which said today it will allow more institutions to participate in its unscheduled cash auctions, sold $50 billion of three-day loans. The Bank of Japan pumped in 800 billion yen ($7.6 billion) and the Reserve Bank of Australia added A$1.57 billion ($1.2 billion).

`Injecting Money’

“The Bank of Japan will have to continue injecting money into the market,” said Yuuki Sakurai, general manager of financial and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., which manages the equivalent of $54 billion in assets. “There is a limit to what the BOJ can do, as a lot of investors are avoiding foreign banks at the moment.”

The U.S. Congress passed a $700 billion financial-market rescue plan today designed to unlock credit markets, reversing a rejection that sent global stock markets plunging and threatened to worsen an economic slowdown.

The legislation, a bipartisan effort to restore confidence in the nation’s banking system, authorizes the U.S. government to buy troubled assets from financial institutions reeling from record home foreclosures. The bill contains $149 billion in tax breaks and affirms regulators’ power to suspend asset-valuing rules that companies blame for fueling the crisis.

Rates on three-month Treasury bills declined for a third day, dropping 11 basis points to 0.49 percent. They touched 0.02 percent on Sept. 17, the lowest since the start of World War II.

Central Bank Rates

The likelihood that the squeeze will push the global economy into a recession has made it more probable central banks will cut interest rates. ECB President Jean-Claude Trichet said yesterday policy makers have already considered reducing borrowing costs. Economists at Citigroup Inc., BNP Paribas SA, JPMorgan Chase & Co. and Royal London Asset Management say the Bank of England will cut its rate 50 basis points next week.

The Libor for overnight dollars fell to 1.996 percent today, below the Federal Reserve’s target rate for the first time since Sept. 14 last year. Futures on the Chicago Board of Trade showed a 100 percent chance the Fed will reduce the rate by at least 25 basis points at its Oct. 29 meeting, up from no chance a month ago.

Hong Kong’s three-month interbank rate rose 2 basis points to 3.81 percent today, and Tokyo’s increased 1 basis point to 0.87 percent, both the highest since December. Singapore’s rate for U.S. dollar loans climbed 11 basis points to 4.27 percent, the most expensive since Jan. 11.

Libor’s Reach

“The interbank lending market remains clogged up as banks hoard cash,” said Joshua Williamson, a senior strategist at TD Securities in Sydney. “Funding pressures look likely to remain high and the longer they stay up there the greater the chance banks will pass on those costs to clients.”

Libor, set before noon in London every day after a survey conducted by the British Bankers’ Association on the cost of dollars, euros and eight other currencies, determines prices for financial contracts valued at $393 trillion as of Dec. 31, influencing consumer interest rates on everything from home loans to credit cards. Euribor, a survey of 37 banks solely on the cost of borrowing euros, is fixed by the European Banking Federation about two hours earlier.

Interbank rates have soared for a third week as governments in Europe and the U.S. rescued at least six financial institutions in the past five days. Writedowns and losses around the world have surpassed $588 billion since the start of last year, according to data compiled by Bloomberg.

The difference between what banks and the U.S. Treasury pay to borrow money for three months, the so-called TED spread, was at 386 basis points today. The spread was 113 basis points a month ago.

To contact the reporters on this story: Justin Carrigan in London at jcarrigan@bloomberg.net

Edge of the Abyss

By PAUL KRUGMAN

 New York Times: October 2, 2008

As recently as three weeks ago it was still possible to argue that the state of the U.S. economy, while clearly not good, wasn’t disastrous — that the financial system, while under stress, wasn’t in full meltdown and that Wall Street’s troubles weren’t having that much impact on Main Street.

But that was then.

The financial and economic news since the middle of last month has been really, really bad. And what’s truly scary is that we’re entering a period of severe crisis with weak, confused leadership.

The wave of bad news began on Sept. 14. Henry Paulson, the Treasury secretary, thought he could get away with letting Lehman Brothers, the investment bank, fail; he was wrong. The plight of investors trapped by Lehman’s collapse — as an article in The Times put it, Lehman became “the Roach Motel of Wall Street: They checked in, but they can’t check out” — created panic in the financial markets, which has only grown worse as the days go by. Indicators of financial stress have soared to the equivalent of a 107-degree fever, and large parts of the financial system have simply shut down.

Paul Krugman

There’s growing evidence that the financial crunch is spreading to Main Street, with small businesses having trouble raising money and seeing their credit lines cut. And leading indicators for both employment and industrial production have turned sharply worse, suggesting that even before Lehman’s fall, the economy, which has been sagging since last year, was falling off a cliff.

How bad is it? Normally sober people are sounding apocalyptic. On Thursday, the bond trader and blogger John Jansen declared that current conditions are “the financial equivalent of the Reign of Terror during the French Revolution,” while Joel Prakken of Macroeconomic Advisers says that the economy seems to be on “the edge of the abyss.”

And the people who should be steering us away from that abyss are out to lunch.

The House will probably vote on Friday on the latest version of the $700 billion bailout plan — originally the Paulson plan, then the Paulson-Dodd-Frank plan, and now, I guess, the Paulson-Dodd-Frank-Pork plan (it’s been larded up since the House rejected it on Monday). I hope that it passes, simply because we’re in the middle of a financial panic, and another no vote would make the panic even worse. But that’s just another way of saying that the economy is now hostage to the Treasury Department’s blunders.

For the fact is that the plan on offer is a stinker — and inexcusably so. The financial system has been under severe stress for more than a year, and there should have been carefully thought-out contingency plans ready to roll out in case the markets melted down. Obviously, there weren’t: the Paulson plan was clearly drawn up in haste and confusion. And Treasury officials have yet to offer any clear explanation of how the plan is supposed to work, probably because they themselves have no idea what they’re doing.

Despite this, as I said, I hope the plan passes, because otherwise we’ll probably see even worse panic in the markets. But at best, the plan will buy some time to seek a real solution to the crisis.

And that raises the question: Do we have that time?

A solution to our economic woes will have to start with a much better-conceived rescue of the financial system — one that will almost surely involve the U.S. government taking partial, temporary ownership of that system, the way Sweden’s government did in the early 1990s. Yet it’s hard to imagine the Bush administration taking that step.

We also desperately need an economic stimulus plan to push back against the slump in spending and employment. And this time it had better be a serious plan that doesn’t rely on the magic of tax cuts, but instead spends money where it’s needed. (Aid to cash-strapped state and local governments, which are slashing spending at precisely the worst moment, is also a priority.) Yet it’s hard to imagine the Bush administration, in its final months, overseeing the creation of a new Works Progress Administration.

So we probably have to wait for the next administration, which should be much more inclined to do the right thing — although even that’s by no means a sure thing, given the uncertainty of the election outcome. (I’m not a fan of Mr. Paulson’s, but I’d rather have him at the Treasury than, say, Phil “nation of whiners” Gramm.)

And while the election is only 32 days away, it will be almost four months until the next administration takes office. A lot can — and probably will — go wrong in those four months.

One thing’s for sure: The next administration’s economic team had better be ready to hit the ground running, because from day one it will find itself dealing with the worst financial and economic crisis since the Great Depression.