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August 22, 2007
The jawboning appears to be working
From today's NY Times:
Fed officials and top Treasury officials continued on Tuesday to talk by telephone with major banks, encouraging them to borrow from the discount window and repeating that there was no stigma associated with such loans. Traditionally, banks have only resorted to the Fed’s discount window when they had no other place to borrow money.
And Reuters now reports (ticker symbols and links removed)
NEW YORK (Reuters) - The four largest U.S. banks, led by Citigroup and Bank of America Corp. took the unusual step of borrowing $2 billion directly from the Federal Reserve on Wednesday, as the Fed tries to stabilize tempestuous financial markets by adding money to the banking system.
U.S. shares rose after the move, but financial stocks declined slightly.
Borrowing money directly from the Fed is usually seen as a sign of weakness, but JPMorgan Chase & Co., Bank of America and Wachovia Corp., said they have ample access to funds and made the move for the sake of the financial system. Citigroup, meanwhile, said it borrowed funds for customers; but the bank has issued at least $2.5 billion of corporate bonds this month.
The Wall Street Journal also carries a story and adds that the borrowing was $500 million by each bank.
It is important to point out that the stigma associated with discount window borrowing is largely a holdover from the days when it really was a discount. And so even today, there is still a reluctance among banks to go to the discount window that goes beyond the fact that now it is above the fed funds target. An excerpt from this Reuters story shows that people haven't totally figured out how to handle this. Again, the reference is to the four major banks stepping up to the window in what was obviously a coordinated move.
Analysts said the move could be encouraging for the market after the Fed said that using its discount window would be considered a sign of strength.
"I'm not sure if it's positive or negative. (But) if there are no problems, then they wouldn't have to borrow, so that could raise a flag," said Steve Goldman, market strategist, Weeden & Co. in Greenwich, Connecticut.
I think it's positive, and here's why. The coordinated nature of the move is meant to inspire confidence. They are not doing this because they had to do it today--and this is why it is important that the term of the discount window loans has been extended to 30 days as well. These four banks just took out a total of $2 billion in reserves over and above what they need. They will now be able to extend short term credit to their clients at nearly the same rate. There is still likely to be some small cost to the banks, so this isn't something that one of them would do themselves unless they had been on the receiving end of those phone calls from the Fed and the Treasury.
But this is going to allow some additional liquidity to circulate privately for a few weeks to help arrange for a more orderly workout of the situation. The four banks benefit from that just as everyone else does. Everyone needs to take a step back and see that this is exactly the sort of thing we've been hoping for.
It looks as if a lot of market participants are in a position where they are not yet ready to go to the lender of last resort, but they are feeling squeezed nonetheless. And this is throwing sand in the gears of the system. The Fed is the lender of last resort, but what can they do if troubled institutions are not yet at the panic stage where they need the Fed's emergency help.
They do exactly what they have done. They extend credit to institutions at the top of the private credit structure and encourage (jawboning or moral suasion) them to act as the "lender of next-to-last resort". In so doing they reaffirm that this is not an interest rate problem but a liquidity problem. This looks like a very encouraging development, and I wouldn't be surprised to see more of it in the coming weeks. Though some see this as a precursor to a cut in the funds rate, I do not. I see it as been an attempt to stave off a rate cut unless these problems affect the broader economy. If this plan works as they want it to, it is more likely to be contained and thus the need for a rate cut is decreased.
Posted by William Polley at August 22, 2007 01:05 PM
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Comments
Bill, great work as always, $2 Billion to four tapped out banks, thats nice.
Kinda like putting Phisohex and a bandaid on a decapitated hand.
Note: there is $400 Billion LBO ABCP already trapped in the pipeline and on the banks books.
What happens when $550 Billion (which is 50% of the ABCP market) matures in the next 90 days?
Thats almost $1 Trillion in ABCP that either gets sold or goes on the banks books.
Can you say massive extensions where possible? I can.
Can you say fire sales? I can.
Can you say BK's and commercial bank failures? I can.
Is that a light at the end of the tunnel? Better hope the brain trust comes up with a solution and fast.
All will be told in the next 90 - 120 days.
Posted by: The Nattering Naybob at August 22, 2007 09:46 PM