Monday, 17 March 2008

A busy weekend for the Fed

The Federal Reserve had a busy weekend. Bear Stearns was mercilessly killed off, while the Fed introduced a new lending facility, effectively reducing its collateral standards. It also cut its lending rate and increased the maturity of its liquidity support.

Bear Stearns is dead

The speed with which the Fed dealt with Bear Stearns was impressive. The Bank asked for liquidity on Friday morning and it was dead by Sunday evening; sold to JP Morgan for the shockingly low price of $2 a share, picking it up for just $236 million - 1.2 percent of Bear's market value a little more than a year ago. The Bear's shareholders were wiped out, sending out a healthy signal to other bankers. If you take large risks, there will be retribution.

This stands in stark contrast to the foolishness surrounding Northern Rock. The Fed had no time for any "market based solutions". The Fed just asked JP Morgan to name its price and they came back with $2. "Fine", said the Fed and that was the end of it.

The incredibly low price can only mean one thing - Bear Stearns was not just short of cash, it was almost insolvent and had broken through the risk-weighted capital adequacy ratios. JP Morgan now has to absorb a pile of poisonous debt, but in return gets hold of the fifth largest investment bank.

The lesson is harsh - any US bank looking like it might be in trouble had better get a fresh injection of capital. Otherwise, the Fed will kill it off.

Yet another Fed Lending facility

The Fed have introduced a new temporary lending facility. Under this new arrangement "credit...may be collateralized by a broad range of investment-grade debt securities." Basically, the Fed have further loosened their collateral standards in order to get liquidity.

The inference here is bleak - US banks are short of high quality collateral, and the Fed needs to loosen its lending criteria in order to pump more liquidity into the banking system. There is no getting away from it, the US banking system is in a deep hole right now.

The Fed cuts rates again

The Fed cut its lending rates to banks. With immediate effect, the primary credit rate was cut from 3.5 percent to 3.25 percent. This step lowers the spread of the primary credit rate over the Federal Open Market Committee’s target federal funds rate to 0.25 percentage point.

The Fed also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days. The increase in maturities indicates that the crisis could be around for quite a while.

Any lessons here for the UK?

The Bank of England should be making copious notes from this weekend's action in New York. First, if any bank does start to slip, do not mess around. Quasi-solvent banks should not be tolerated. If you can not sell it within two days, liquidate it. There should be no mercy given to failing banks.

The BoE, along with their sleepy colleagues over at the FSA, should also recognize that this crisis will be long and protracted. The balance sheets UK banks should be thoroughly reviewed. If any bank looks even a little shaky, deal with it now. Sell it off or close it down before there is even a hint of any solvency problems.

Rapid upfront action will calm the situation down and reassure everyone that the remaining banks are solid. Killing off a few weak banks would be a downpayment on re-establishing the crediblity of both institutions. It is a win-win no brainer.

The alternative, delay and compromise - will mean disaster.


Anonymous said...

Yes, there's so much uncetainty around at the moment your suggestions make perfect sense. Who would be able to take on such potential liabilities over here though? Lloyds perhaps, they've only had a small amount of exposure to sub-prime. Not sure who else, transparency is crucial at the moment it does however bruise Brown's ego though if things aren't as rosy as they should be.


Alice Cook said...


Our problems will not come from subprime. We have been cooking up our very own banking problem - BTL. As I said in the post, we need some decisive upfront action on the banks now. Weed out the weak and kill them off.


traderboy said...

i'm not sure BTL is what will bring the UK market down (although I'm sure it will contribute), i think it could be a more traditional "crash" whereby people over-borrowed, and once unemplyment and interest rates go up, their ability to finance stops.

even in London, it's easy to see that there are going to be banking layoffs, followed by less business for others who provide work for them, like lawyers, IT contractors, taxi drivers, followed by estate agents, mortgage bankers, architects, plumbers, electricians, and i'm sure plenty others.

At the other end of the pay scale, your average joe is now competing for jobs with Eastern Europeans who I'm sure will (on a general basis) be willing to work for less, so pushing wages down.

And while we're at it, a cash-strapped government will be doing its best to pull in its crazy public spending, so possibly meaning lower pay or lower employment of teachers, nurses, policeman, fireman etc etc.

I'm struggling to see how any of the above CAN'T happen?

Tubby Jones said...

I like the idea of an upfront review of UK balance sheets. Seems to make a lot of sense. Find out what is out there and deal with it before it goes bad.

Anonymous said...


I like how this blog is morphing from just UK housing into economy wide issues that ultimately effect housing. Volume in comments has been pretty low so far but it won't be long before word is out. Just look at how CalculatedRisk went from a nerdy blog to pulling in 500 comments on recent posts and getting MSM references.

Keep it up! I for one look forward to your posts.


Anonymous said...

Regarding public sector - California just laid off 20,000 teachers. We are headed in that direction, although unlike the US states the UK government doesn't have to balance it's budget every year. So they'll try to borrow and tax first.


Anonymous said...

Alice: ¨The Bank of England should be making copious notes from this weekend's action in New York.¨

A little unfair! The Bank of England wrote the book on banking crises.

It was our prudent chancellor, one Gordon Brown, who is now ( God Help Us ) the prime minister, who took the duty to regulate the british banking system from the Bank of England, and gave it to the FSA, which other than knowing how to raise funds for itself, couldn´t find its anal orafice from its elbow.

Anonymous said...

"the FSA, which other than knowing how to raise funds for itself, couldn´t find its anal orafice from its elbow."

It's like a sleeping guard dog suddenly barking and yelping to prove to it's master it wasn't sleeping on the job. Notice the finance ombudsman is getting in on the act too. During the bubble the banks wouldn't lend enough for him, and durinf the bust they were lending too much.


dr ray jo said...


For the record, and in case you didn't know, J P Morgan are a major shareholder in the private entity called the Federal Reserve, who have just effectively offered it $30B of taxpayer's money as collateral to buy a rival. Google it if you are doubtful (obv.!).

Ain't capitalism grand!

Anonymous said...

dr ray jo said...

¨Ain't capitalism grand!¨

Technically, I wouldn´t call it capitalism. More like facisism actually. Which by the way, is akin to communism.

We are now witnessing a state take over of private buisnesses. The correct thing to have done would be to have left Northern Rock and/or Bear Stearns go bankrupt, the capatalist vultures would have picked over the carcas, in the long run we would all have been better for it.

This is state directed commerce, entirely different from capitalism, and much nastier!