The Global Bailout

Econintersect: A coordinated emergency move has been made by a cadre of world central banks, the likes of which has not been seen since the collapse of Lehman Brothers over three years ago (see central bank statements at end of article).

The U.S. Federal Reserve, the European Central Bank, and the central banks of Japan, Britain, Canada and Switzerland launched a liquidity campaign to fund a credit crunch among European banks. In addition it appears that Germany may be relenting on its opposition to adding more capital to the IMF (International Monetary Fund).

Although the actions of the central banks are reminiscent of the 2008 crisis, there are no indications as yet that the current situation will take the global financial system to the edge of a cliff as happened then, although there have been some who have predicted the European crisis could be worse. World stock markets have rallied strongly, reacting positively to both the rumor (on Monday) of progress in addressing a bank run mentality in Europe and again on the news of action on Wednesday. There was no buy the rumor, sell the news mentality here; the market bought both.

Italy is the current focal point of the sovereign debt/banking crisis in the Eurozone, and that the government was also in action Wednesday. The Italian Treasury started emergency cash tenders for banks which have been squeezed particularly hard as Rome’s borrowing costs have soared towards 8 percent. It is not believed that Italy will be able to service its debt at such high interest costs.

In spite of the wild elation of the past three days, there are those who think that much remains unsettled. Reuters summarized where things stand:

“The economic and monetary union will either have to be completed through much deeper integration or we will have to accept a gradual disintegration of over half a century of European integration,” Economic and Monetary Affairs Commissioner Olli Rehn told the European Parliament.

Two years into Europe’s debt crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, south European banks are bleeding deposits and a recession looms, fuelling doubts about the survival of the single currency.

Euro zone leaders have agreed belatedly on one half-measure after another but have failed to restore confidence and some analysts now see a Dec. 9 Brussels summit as a make-or-break moment for the euro.

Finance ministers agreed on Tuesday night on detailed plans to leverage the European Financial Stability Mechanism (EFSF), but could not say by how much because of rapidly worsening market conditions, prompting them to look to the IMF.

“We are now looking at a true financial crisis — that is a broad-based disruption in financial markets,” Christian Noyer, France’s central bank governor and a governing council member of the European Central Bank, told a conference in Singapore.

An excerpt from The New York Times presents some other opinions:

Stanley A. Nabi, chief strategist for the Silvercrest Asset Management Group, said the coordinated action signaled that the problem had reached a crisis point, and that the central banks recognized there was a “lot of danger” in letting the current situation continue.

Steve Blitz, the senior economist for ITG Investment Research, said the central banks “are going to do what they can to ring fence the European financials’ problems and keep them inside Europe.”

“They are trying to prevent them from seizing up global liquidity and capital flows and impacting banks and financial institutions throughout the world,” he said.

Burt White, the chief investment officer for LPL Financial, called the liquidity move “a Band-Aid.”

“It helps to prop up the banks for a while, which is going to buy time for Europe to fix the problem,” he said.

Finally, Lance Roberts of Streettalk Live has written cautionary words about the potential for longer term negative effects for investment markets as a result of the “massive liquidity boosts” impacting consumption because of resulting commodity inflation.

Note: Lance Roberts has been a guest author at Global Economic Intersection.

US Federal Reserve Statement:

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.

These central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from December 5, 2011. The authorization of these swap arrangements has been extended to February 1, 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.

As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorized through February 1, 2013.

Federal Reserve Actions
The Federal Open Market Committee has authorized an extension of the existing temporary U.S. dollar liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank through February 1, 2013. The rate on these swap arrangements has been reduced from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. In addition, as a contingency measure, the Federal Open Market Committee has agreed to establish similar temporary swap arrangements with these five central banks to provide liquidity in any of their currencies if necessary. Further details on the revised arrangements will be available shortly.

U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses.

Information on Related Actions Being Taken by Other Central Banks
Information on the actions to be taken by other central banks is available on the following websites:

Bank of Canada