Tuesday, 11 March 2008

The central banks are at it again

Yes, yet another attempt to "stabilise financial markets" is under way. The world's central banks are again coordinating a another major liquidity injection; the third one since August.

These stabilisation efforts appear to be getting more desperate. Something is wrong with the our banks. Underneath those balance sheets there is something rotting and festering. Fear and panic has now gripped the world's central banks and cash is now flowing into the financial system in an effort to cover the putrid smell.

This is how the Bank of England announced today's efforts:

"Since the co-ordinated actions taken in December 2007, the G-10 central banks have continued to work together closely and to consult regularly on liquidity pressures in funding markets. Pressures in some of these markets have recently increased again. We all continue to work together and will take appropriate steps to address those liquidity pressures."

Over in the States, the Fed is thinking big. It announced a new lending facility:

"Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS."

Similar announcements were made by the ECB and the Swiss central bank. However, the problem here is solvency not liquidity. Banks around the OECD have tangled themselves up an a massive housing bubble, and now it is all going south. Bank balance sheets are beginning to deteriorate.

There is a simple inescapable truth behind this crisis. If someone defaults on a loan, the loss must show up somewhere. At the moment, that "somewhere" is the balance sheets of commercial banks.

Over the last few months, banks, particularly the big ones on Wall Street, have begun telling central banks that these losses are becoming unbearable. So, the central banks are now moving those losses from the commercial banks and unto the government's balance sheet.

These liquidity injections are the mechanism by which these banking losses will be nationalized. Strip away the weird acronyms, and the operation amounts to a simple exchange. The central banks hand out cash and in return, it receives a rotten mortgage backed security. What is behind this MBS? Why, it is a bundle of bad housing loans, which are ultimately claims on borrowers houses.

There is a strange irony here. For years, successive governments in the US and UK pushed the idea of home ownership. Public policy aimed at building up home ownership at the expense other priorities. For example, in the US, mortgage interest is deductible, while income used to pay rent was fully taxable. The financial sectors in both countries were liberalized; thus setting off a chain of events that led directly to the crisis we see today.

The UK experience is particularly galling. During the Thatcher years, billions of pounds of public assets - council houses - were privatized on the cheap. Tax payers money build those houses, and when they were sold, there was a massive transfer of wealth from the state to private individuals. Then the banking system financed a massive bubble; it is now collapsing and the state is stepping in and buying up claims on houses. With Northern Rock alone, the state pumped in £30 billion and guaranteed a further £70 billion.

So public ownership of housing is back, proving my dear old grandma right once again. As she always says: "What goes around, comes around".


Ray said...

While reading your article, I couldn't get the face of Tony Benn out of my mind. He was signing,

"Socialism, Socialism, nah, nah, n-n-n nah"

Lets keep this nationalization thing going. After housing, lets move onto utilities, railways, and coal mines.

The Real Lizzy said...

I wish someone would give me a liquidity injection. Do you think if I offered the BoE some collateral, they would give me some cash?

Fester Bestertester said...

Monster rally on Wall Street: they refuse to let the patient go naturally. The corpse already stinks. "Fie, fie, tis an unweeded garden that grows to seed. Things rank and gross in nature possess it merely."

Ghostwriter said...

The Fed is essentially saying to the banks: give us your crap securities (which are now unable to be valued) as collateral and we will give you cash for them now. The Fed does not have to worry about whether these securities will ever recover any of their wortrh. They are taking the insolvency problem away from the banks. It's the biggest "Get Out of Jail Free" card ever. I'm not clairvoyant, so I can't say what kind of repercussions this operation will have--but the Fed has likely saved Wall Street with this. It will not stop the housing crash, however.

Anonymous said...

The central banks are becoming Wall Street's pawnbrokers. The facility is $200bn because that's how much agency paper the prime brokers hold. So by swapping all this junk for treasuries it prevents the banks from suffering margin calls, for now, and further postpones the mass sell-off.

It doesn't come anywhere near fixing the problem though. The great leverage unwind is upon us and nothing will stop it. This is the phase where we learn cash and credit are two different beasts.


Anonymous said...

Ghostwriter, you beat me by a minute! The Fed isn't giving cash, it's giving treasuries. It's an asset swap to change the composition of the banks' balance sheets to delay forced selling. It's not inflationary. It won't work. And it will be rolled over many times following the so-called 28-day limit.


Anonymous said...

There's one stat I would love to know from the NR saga. That is the difference between the sum the council housing stock have been sold off at and the what they have been repurchased via the nationalisation of the Rock. I'm not sure Brown/Darling are likely to release that sort of info tho..