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Who will trust the banks if they don't?

by Jerome a Paris
Wed Oct 15th, 2008 at 08:55:42 AM EST

While the cost of three-month dollar loans has dropped in the wake of the measures, it is still 305 basis points more than the Fed's target rate. The difference was a record 332 basis points on Oct. 10. It was 82 basis points on Sept. 15, the day Lehman Brothers Holdings Inc. filed for bankruptcy and 11 basis points on July 31, 2007, just before the start of the credit squeeze. (Bloomberg)

(click for larger version)

The above represents the price, set by banks themselves, of the risk of banks going bankrupt in the short term. The recent trillions have stopped the increase of that price, but have hardly brought it down to anything resembling normalcy, which means that lending is still effectively frozen.

As this has been the case for more than a couple weeks now, it is trickling directly into the real economy, as no new loans are being made, and existing ones are called in whenever possible. Many companies can play around for a bit of time, but many more will soon run out of options.

Fundamentally, the solution to this has been to entrust the banks with trillions of money, in the hope that they will start lending again. But banks themselves don't trust the banking sector to do its job. It looks like a long term solution will be to rebuild an untainted financial sector, focused on a more limited number of tasks, keep it on a short leash, and let the old one die.

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Who will trust the banks if they don't? | 14 comments (14 topical, 0 editorial, 0 hidden)

Re: Who will trust the banks if they don't? (none / 0)

Has there been enough time for interbank lending rates to drop? Should this have happened immediately after the injection?

What would the long term solution of rebuilding an untainted financial sector actually look like, and how would we get there?

Isn't part of the Paulson game plan to fund the "winners" so through consolidation they have even more control? How do we end that?

Though it would be keen to see a new sector emerge (as it must happen to some degree anyway), is this possible?

Skennah Kowa

by Crazy Horse on Wed Oct 15th, 2008 at 09:10:10 AM EST

Re: Who will trust the banks if they don't? (none / 0)

It looks like a long term solution will be to rebuild an untainted financial sector, focused on a more limited number of tasks, keep it on a short leash, and let the old one die.

Exactly! If this round of "capital injection" doesn't do it, why should another round? Why provide capital to those who are rightly afraid to use it?

Rather than flushing more money, every country that has problems should concentrate on funding new, untainted banks. If ideology obstructs, promises could be made to put these banks up for sale on usual commercial terms in a few years. Right now we have industry and trade at risk from un-availability of credit, we have commodities dealers unable to pay up on contracts issued in March and April and we have states and municipalities facing bankruptcy because they cannot get affordable financing on short term credit, just in the USA. Like there won't be knock-on effects from these problems? Death spiral, anyone? Its a choice between ideology and the economy.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Oct 15th, 2008 at 11:39:15 AM EST

Re: Who will trust the banks if they don't? (none / 1)

Commercial banking needs competition now. What else would move banks to do what they are supposed to do - to lend?

Why couldn't government offer that banking competition, instead of distributing allowances? Libertarian exclusion of government from markets takes away some crucial salt from the economic ecosystem, I think.

by das monde on Thu Oct 16th, 2008 at 02:54:03 AM EST
[ Parent ]

Re: Who will trust the banks if they don't? (none / 0)

Commercial banking needs competition now. What else would move banks to do what they are supposed to do - to lend?

Exactly! Businesses need to be able to finance their opperations now, exporters need letters of credit now, etc., etc. The Fed and FDIC should be working together to identify and certify existing banks that have sound balance sheets. It might help were the bank officers made personally responsible to the full extent of their personal assets, including trusts they have created, for the costs due to any bank asset that is not brought to the attention of examiners. They, of course wouldn't likely be able to pay for the damage, but it would be a powerful deterrent to "forgetting" certain obligations.

Capital injected into sound banks would be lent to credit-worthy borrowers. If these banks lacked experienced commercial banking officers, there should be many looking for positions about now. Part of the FDIC's procedure for disposing of insolvent banks should be to see that the commercial lending operations of such banks are taken over by certified sound banks and that new capital proportionate to that department's size be injected into the recipient bank.

Why couldn't government offer that banking competition, instead of distributing allowances?

The Federal Reserve Bank System is the only institution of which I am aware that could perform such functions, and their primary function is regulating the money supply, interest rates and banks. They would be in an inherent conflict of interest and mission were they to take on large scale banking themselves. Besides, they have been busy trading all of their treasury notes for toxic waste from AIG, etc. and would be just another poisoned bank at this point.

Bruce McF has suggested upgrading credit unions to full service banks. That should also work. Why Paulson is not being called out for only taking obviously doomed actions is beyond my limited understanding if indeed there are explanations beyond my cynical expectations of his desiring to protect his cronies and his being blind to the needs of anyone outside of the world he came from.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Thu Oct 16th, 2008 at 11:38:41 AM EST
[ Parent ]

Re: Who will trust the banks if they don't? (none / 0)

Yep, there is no differentiation of sound and foolish banks whatsoever.

I am still trying to understand how federal or private the Federal Reserve System is. "Conspiracy theorists" say that it is just as federal as Federal Express. Officially, it is quasi-public (government entity with private components), but how many quasi-public entities do we have? How is Federal Reserve accountable? How independent is politics from it?

by das monde on Fri Oct 17th, 2008 at 05:53:20 AM EST
[ Parent ]

How badly has the credit union sector been hit? (none / 1)

Does it vary in different countries?

I had the impression that in the US, when a credit union wanted to misbehave, the first thing it did was transition to a commercial bank so that it could misbehave ... ditto in Oz.

If the credit union sector is not badly hit in terms of balance sheets, helping them expand into commercial lending with capital on tap from the Fed would sidestep the market-intermediation tail wagging the core commercial banking business dog and all the toxic effects that have ensued.

Of course, the commercial bankers hate the credit union sector, so there's also a good moral hazard preventative built into that ... misbehave again, and lose more market share.

Utsukushikereba sore de ii

by BruceMcF (agila61 at netscape dot net) on Wed Oct 15th, 2008 at 12:40:21 PM EST

You can't fix LIBOR, abolish it. (4.00 / 5)

LIBOR is broken for good, even if all banks now trust each other to be backed by governements, they have no reason to lend unsecured, to banks who have no reason to borrow anyway (since they can always borrow cheaper at the ECB/Fed/Whatever, against whatever collateral).

The central banks are the new "funding tills". LIBOR means nothing now, because the quotes given by the panel banks are just sticking a finger in the air: They have no demand for interbank loans, no need to make competitive offers.

In order to minimize damage to the real economy (through LIBOR-indexed variable rate loans), the regulators in all OECD countries should abolish libor and decree that by new law, all outstanding contracts mentioning a LIBOR tenor shall now use the target rate of the central bank plus a small tenor-related spread.

I'm appalled that still no-one has thought about fixing this disaster...

Pierre

by Pierre on Wed Oct 15th, 2008 at 01:50:30 PM EST

Heh (none / 1)

It's not a market solution, so it can't work, by definition.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (jeromeguillet@yahoo.fr) on Wed Oct 15th, 2008 at 02:57:21 PM EST
[ Parent ]

Re: Heh (none / 0)

I think it's more sinister than that.
Keeping this inflated LIBOR (which was never even truly measured -that's something that is quite shocking since it is the basis of so many loans) up is a way to make insolvent banks more solvent.
Variable rates not only have become a real pain for those who hold such loans, they are a bonanza for banks. An extra 4% on return. Impressive.

"The womb that spawned that thing is fertile yet"

by Cyrille (cyrillev domain yahoo.fr) on Wed Oct 15th, 2008 at 04:39:43 PM EST
[ Parent ]

Re: Heh (none / 0)

But the complaints so far is that banks have under-quoted LIBOR for fear of admitting that they can't really find funding at that price anymore.

And I tend to agree - when banks have interna lfunding costs that are LIBOR+200 points, somethign is very wrong with LIBOR - ie it's too LOW, not too high.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (jeromeguillet@yahoo.fr) on Wed Oct 15th, 2008 at 05:05:25 PM EST
[ Parent ]

Re: Heh (none / 0)

It's pretty much LIBOR internally here.

"The womb that spawned that thing is fertile yet"

by Cyrille (cyrillev domain yahoo.fr) on Thu Oct 16th, 2008 at 12:56:11 AM EST
[ Parent ]

Re: Heh (none / 0)

To clarify: regulators may deliberately keep this (temporarily, hopefully) meaningless LIBOR and maybe even encourage its staying high as a way to prop up the financial sector.

"The womb that spawned that thing is fertile yet"

by Cyrille (cyrillev domain yahoo.fr) on Wed Oct 15th, 2008 at 04:42:10 PM EST
[ Parent ]

Stupid question allowed? (none / 0)

Why is the spread different between dollar and Euro interbank loans? Is it a question of the time period involved for the loan or am I just misunderstanding the charts?

by Detlef (Detlef1961_at_yahoo_dot_de) on Wed Oct 15th, 2008 at 05:45:20 PM EST

I think (none / 0)

it is that dollars have been scarcer to find for non-US banks, which constitute a big part of the market, thus the higher price.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (jeromeguillet@yahoo.fr) on Wed Oct 15th, 2008 at 06:08:32 PM EST
[ Parent ]

Who will trust the banks if they don't? | 14 comments (14 topical, 0 editorial, 0 hidden)

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