On November 30, the Fed, ECB, Bank of England, Bank of Japan, Bank of Canada and Swiss National Bank acted together to cut the rate on dollar liquidity swap arrangements by 50 basis points. Markets surged. Irrationally trumped reason.
What, in fact, was accomplished? Swap lines were always available. From 2007 – 2009, they were initiated or expanded globally four times.
Lowering the price modestly was done to ease pressure on troubled Eurozone countries. However, funding isn’t the problem. It’s solvency. Nonetheless, the ECB perhaps agreed to be lender of last resort, at least to some degree.
Expanding its balance sheet may lower sovereign debt yields. At issue is the ECB’s ability and willingness to tackle a $6 trillion debt problem when serious restructuring is needed. Kicking the can further down the road won’t work.
The November 30 announcement “looks to me like a non-event. Yet markets went wild. Are they taking this as a signal that substantive action – like the ECB finally doing what has to be done – is just around the corner? Are they misunderstanding the policy? Was this cheap talk that nonetheless moved us to good equilibrium?” If so, it’s not enough. Italian bonds still top 7%.
Pimco’s Tony Crescenzi believes “liquidity is no substitute for other actions that Europe must take to solve its current woes. The world continues to wait on European actions on fiscal rules, discipline, and enforcement, as well as use of the balance sheet that matters most in the current situation: the European Central Bank.”
Smith also wondered why markets reacted so positively to what little, in fact, was done. He also focused on two underreported issues, including acute withdrawal of dollar funding from Eurobanks.
As a result, he believes coordinated Fed action was less about reducing interest rates and more about systemic seizing up. The response was “telling the markets they were on the case.”
However, “this is giving a probably dying patient emergency oxygen when he needs to be put in intensive care.”
Smith also mentioned Nouriel Roubini saying Italian sovereign debt needs to be written down. If the ECB buys it, “the result will be that pretty much every private holder will hit its bid. And he doubts the ECB is prepared to balloon its balance sheet up” to $1.9 trillion or higher.
That amount deals with Italy alone, excluding five other troubled Eurozone members.
Commenting on Italy’s unstable condition, Roubini said it needs “a primary surplus of 5 per cent of (GDP), not the current near-zero, merely to stabilize its debt. Soon real rates will be higher and growth negative. Moreover, the austerity that the (ECB) and Germany are imposing on Italy will turn recession into depression….”
Roubini also said debt restructuring is needed with investors sharing the burden to reduce public debt “to at worst 90 per cent of GDP from the current 120 per cent.”
However, with bondholders unwilling to take losses, resolution won’t be forthcoming. Instead of tough action, policy measures have lurched from one bad solution to another. As a result, expect more stopgap measures after current ones fail.
Nomura’s banking research head Jon Peace said coordinated Fed action stems from a three-year old crisis. “Back in 2008, there was a lender of last resort – countries bailed out the banks. This time it is governments that need a lender of last resort – but there is no obvious” one available to handle a crisis this great.
Moreover, warnings accompanied November 30′s announcement about its seriousness. France’s central bank governor, Christian Noyer, said “We are now looking at a true financial crisis – that is, a broad-based disruption in financial markets.”
“The whole thing smells fishy….Aside from the fact that the Fed leaked its intentions….Monday night,” something doesn’t wash.
Action perhaps was to help institutional investors and insolvent banks like Bank of America. Moreover, other tried options failed. The Fed stepped in to help. “That alone should have everyone worried….about how dire things had become in Europe.”</blockquote>
Of greatest concern is that coordinated Fed action solved nothing. It was little more than feel good. Troubled Eurozone countries have unresolved solvency issues. Lowering interest rates won’t help. All it does is provide easier credit “which, of course, is the entire problem to begin with.”
Banks are highly leveraged. Progressive Radio News Hour regular Bob Chapman says 70 to 1.
At this level, small losses can mean bankruptcy. Providing more liquidity makes a bad situation worse. Core issues remain unaddressed, including too little capital and too much leverage when economic conditions are dire. It’s like betting against the house that always wins. Only fools try.
At best, coordinated Fed action bought time, but not much. “Neither math nor common sense indicate that this will turn out well. Indeed, when this mess finally comes undone, it’s going to make Lehman (Bros.) look like a joke.”
“We’re now talking about entire countries collapsing, not just private institutions.”
Naive investors will lose everything. It’s no time to be brave and bold.