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Wednesday October 8, 2008 - 19:49:44 GMT
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Forex Blog - Leaving the Bunker  

Leaving the Bunker

I am starting to think we are close to the end of the banking crisis or as I like to think it will be referred to in history, the end of the Bank Panic of 2008. 

First of all let me define “end” of the panic.   This means stabilization of the crisis and gradual return of interbank lending, commercial paper market, steeper yield curves and confidence in banks from the lowest to the highest levels. 

Today’s joint rate cut from the ECB, Fed, BOE, BOC, SNB and Riksbank (later from PBOC) is less significant in terms of what it can do for restoring bank lending directly than it is for confidence in the highest level of coordinated policy responses.  If G7 were a currency, yesterday it looked like the Thai baht in the Asian currency crisis and today it is looking like the yen.  Don’t get me wrong, I have been as skeptical of G7 effectiveness over the last 8 years as anyone…more like D7 for dysfunctional 7.  But necessity is always the mother of invention and in this case reinvention.  Never has G7 cut rates (or raised them) all at the same time.  Even in Plaza rates were moved in a coordinated fashion but not simultaneously.  And it is no less remarkable that JC Trichet and his band of ECB brothers and sisters joined in the move after having hiked rates in July and met as a policy making body last Thursday when all it could say was it discussed a rate cut but voted unanimously for no change in official rates.  

But more spectacularly, the ECB announced later today that it would provide unlimited funds to the money market at a fixed rate ahead essentially putting a ceiling on cost of official funds.  Additionally the ECB narrowed the band in which it pays interest on reserves held at the ECB and on emergency loans it charges banks for money borrowed from the Bank (like the discount rate) to 100bps from 200bps, something JC Trichet said wasn’t even discussed at Thursday’s press conference when asked by a reporter.  In other words the ECB is acting like the Fed.  A central bank possessed.  A central bank that gets the gravity of the problem.  Look for the ECB to borrow more from the Bernanke playbook ahead.  

The UK response earlier today is also a game changer for UK banks – they will not be allowed to fail.  They may end up with large government stakes but they will not fail and deposits and liabilities have largely been underwritten by the government today and the larger the state buy in the lower the common stock will fall (TARP offers US Treasury the option on buying shares, likely preferred with Buffet like dividends, in financial firms, a far more direct means for recapitalizing a bank and the sooner this starts the better).  And the BOE apart from cutting today is also making an enormous amount of liquidity available to the banking system. 

While the EU leadership meeting at the weekend in Paris and Eurogroup and Ecofin meetings in Luxembourg Monday and Tuesday failed to come up with a systemic response which disappointed many in the market, it was clear from the outset that there could only be an ad hoc state-by-state response to the banking crisis and by its design (monetary union without political union) Europe would be late to the bank rescue game… it will be there in the not too distant future despite the incompetence demonstrated in the last two weeks by the likes of German Finance Minister Steinbreuck who still believes German banks are adequately capitalized for some of the highest leverage ratios of any banks on the planet. 

I can’t even begin to list all of the steps US officials at the Treasury and Fed have taken in the last three weeks…several dozen at least.  It takes time amidst a panic for markets to see the forest for the trees.  But assuming banks start lending to each other and to customers gets started soon, in due course the panic will fade and everyone can then focus on the next key issue or issues.  How long and deep is the global recession ahead and how is it paid for (including bank bailouts) which raises crowding out issues on a massive scale and for large debtor nations questions about currency values ahead?

As for getting interbank lending going, look also for an ad hoc state-by-state response to guarantee bank-to-bank loans…capitalized by governments and as an insurance charging participating banks a fee.  This should be clear by the end of Friday’s G7 meeting in Washington if not before.

As I write, Secretary Paulson is on the TV calling a G20 emergency meeting – perhaps to follow G7 – presumably this weekend to address the financial crisis.  Also Germany and France have announced they will coordinate a dual response to the banking crisis.

Banking business is forever changed and so too is non-banking financial business from hedge funds to insurance companies.  I can’t say when we should get bullish on the future over asset prices, including though not limited to stocks, but I think I can say we should stop being bearish on credit, bank lending and the major solvency issues for G7 financial institutions.  My take is a 2-year recession/stagnation period before business investment and corporate profits revert to the mean.  I think in due course the dollar must weaken versus major currencies (it has versus the yen and has more to go) in due course.  But upside risks for the USD remain as long as investors and speculators are long risk and have a need to deleverage.  And as best I can tell European banks remain highly leveraged and vulnerable to selling assets with or without CDS in place to “harden” credit quality of the banks’ balance sheet.  Europe needs to figure out an orderly process for deleveraging European banks and the sooner the better (super duper SIV can be expected).   

So I am leaving the bunker today, tough I still have my lacrosse helmet on and strapped tightly.  In a week I think I can remove the helmet and stop worrying about buying T-bills, gold and selling everything else.  I may also take my wad of cash at home (zero cost insurance against a bank holiday or closing of ATM networks) and put it back in my local bank.

David Gilmore



 

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