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Wednesday, December 12, 2007


central banks to coordinate efforts to sustain unsustainable lending

per marketwatch:

The Fed said it would inject cash into money markets through some term-auction facilities.

"Under the term-auction facility program, the Fed will auction term funds to depository institutions against a wide variety of collateral that can be used to secure loans at the discount window," the Fed said in a statement.

"By allowing the Fed to inject term funds through a broader range of counterparties and against a broader range of collateral than open-market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress," the Fed said.

The Fed will also establish foreign exchange swap lines with the European Central Bank and the Swiss National Bank.

These arrangements will provide $20 billion to the ECB and $4 billion to the Swiss National Bank.

The first auction of $20 billion will be held on Monday. This auction will provide 28-day term funds maturing on Jan. 17.

The second auction of up to $20 billion is scheduled for Thursday, Dec. 20. This auction will provide 35-day funds maturing on Jan. 31. The third and fourth auctions will be held on Jan. 14 and Jan. 28. The amounts will be determined next month.
The Fed said it may conduct additional auctions in subsequent months, depending in part "on evolving market conditions."

part of the issue troubling the fed recently has been the reluctance of banks to tap the discount window in spite of obvious signs of huge interbank stress and the fed's own efforts to expand the acceptable collateral and reduce the punitive markup on the discount rate. institutions in trouble are very probably afraid of making that trouble explicit by going to the fed hat in hand and sparking a run that destroys them. some discount window loans have apparently been taken through intermediary banks of "unquestionable" strength to disguise the ultimate troubled borrower, but there's enough friction and fear there to have made that borrowing limited, and made the federal home loan bank system (or FHLB, where borrowing is low-profile) much more popular. however, FHLB has expanded its balance sheet incredibly, and must be in a difficult position to offer more help.

so the fed here is essentially disintermediating those big banks and using an anonymous auction to go more directly to the problem. as relayed by bloomberg:

``By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress,'' the Fed statement said.

it is also lending billions in dollars to european banks to ease the very high demand for dollar loans in europe reflected in the ridiculous LIBOR spread.

this is a more focused (and desperate and scared, as floyd norris surmises correctly) effort to reliquify the interbank credit markets that have been freezing up for months, and clearly an adjunct to yesterday's rate cut. the market spiked higher this morning on the news, erasing most of yesterday's post-cut selloff.

it's good to see the federal reserve responding creatively to specific problems, but i can't help but note that this doesn't fix the underlying problem: too much debt, not enough income, not enough collateral, not enough capital. at best, success will be measured by the degree to which the credit collapse is slowed and eased in speed and degree. this because continued credit maintenance, much less creation, is dependent on two things that no longer exist (as noted by yves smith): the health of the securitization model, and strong capital positions in banking.

so save a thought for this: what if it doesn't work?

Under the repo/fractional reserve system the debt can be hidden because it is spread out among many banks. The Fed lending $10 billion (and thus their balance sheet rising by $10 billion) will turn into $500 billion as other banks lend that money out and only keep a fraction of it for themselves. This is not working. Under the “new” plan the Fed will lend directly to each bank. If they want to create $500 billion of new credit the Fed’s balance sheet will increase $500 billion.

This will be obvious to foreigners just like a big cut in the discount rate. This is why gold is up this morning in response to this “new” plan which is really just a hidden discount rate cut: if the Fed is willing to pervert its balance sheet to this extent the dollar will fall.

this is the reason deflation (at least in assets and probably generally) remains the foremost concern in my mind in spite of government efforts at reflation/continuing inflation. marketwatch's irwin kellner thinks as i do -- that we may well be caught in a liquidity trap.

You can lead a horse to water, but you can't make it drink.

We learned this in the 1930s, when, after first shrinking the money supply enough to pull prices down by about 25%, the Federal Reserve of that era tried to force-feed liquidity into the economy with the hopes of pushing it out of its slump.

It didn't work. Lenders were reluctant to lend, while potential borrowers did not want to borrow.

Banks were struggling under mountains of loans gone sour and were in no frame of mind to throw good money after bad. For their part, most firms were not willing to assume new debts, since falling sales and earnings led them to conclude that there was little productive use they could make out of these borrowed funds.

The great economist John Maynard Keynes dubbed this phenomenon a "liquidity trap." It was perhaps the first realization that the Fed's powers were not as great as previously thought.

indeed they are not, as kevin depew knows.

What is important is not that the BIS failed to stop financial crises, but why. The answer is that markets eventually chew through fiscal and monetary intervention in spite of us. So frequently, in fact, almost always, the cure is far worse than the disease. Just something to think about.

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