August 13th, 2007

Loans taken on by banks Temporary like Achilles?

Posted in Money by ed

imnotthere.jpg A third day now of huge loans being dealt out by the central banks in Europe, Asia and North America to keep financial institutions worldwide liquid. (See story copied below.)

Such “injections” of credit are routine, and big injections are routine during a “liquidity crisis.” (Although the amounts so far this time are approximately double the amounts kicked in following the 9/11 attacks.)

The premise beneath this emergency overnight borrowing is that a liquidity crisis is a passing and irrational phenomenon. And that once it passes and the bond markets are again trading, the trillions in sound (?) investments that currently cannot be valued on the borrowers’ books because nobody is willing to buy them will bounce back to status quo ante valuations, leaving the borrower whole — and the emergency overnighters can be returned to the central bank.

But what if (as worried here in recent weeks) the problem is more substantial than a liquidity panic?

That is: What if the damage done to confidence in the methodologies that the Rating Agencies and bond traders use to evaluate the whole vast range of structured finance bonds (ABS, CDOs and similar) lasts into the mid- and long-term?

Answer: The depressed or non-existent “mark to market” values of the illiquid bonds will remain on the books. The borrowing banks will continue to show huge paper losses and continue to need new cash to run their operations. And will be carrying the cost of these emergency loans.

Thus, if this goes on for any length of time, then the strain on the banks will get worse, not better, as the illiquid investments run their lives and reach maturity or other wind-up conditions and are realized as permanent losses.

But how long will “this go on?”

How long will bonds unrelated to subprime mortgages but nevertheless illiquid and “impossible to value” stay that way? Eg, how long will it take for people to believe that a AAA-rated CDO with no subprime mortgages in the collateral pool will perform as a AAA has always been expected to perform?

How long before the stink of mortgage bonds is bleached from trading desks worldwide?

Nobody knows, but there are plenty of reasons to think the crisis in confidence re rating methodology is rational and thus not likely a passing panic. Temporary like Achilles?

imnotthere.jpg See I’m not There.

ECB injects a further $65 billion into banking system

By Simon Kennedy

LONDON (MarketWatch) — The European Central Bank said Monday that it had provided around 47.5 billion euros ($65 billion) in loans as it continued to try and support liquidity in the banking system.

The latest one-day tender from the central bank came on top of a 61 billion euro cash injection on Friday and the 95 billion euros it provided on Thursday as markets continued to suffer from the effects of the subprime credit crisis.

The ECB said the tender had a weighted average rate of 4.07%. Earlier Monday the Japanese central bank added over $5 billion to markets …

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One comment

  1. surfwalker says:

    An interesting schizophrenic condition developing . . . fear exerts an upward pressure on market lending rates while massive liquidity injections (nice metaphor) should go hand in hand with lowered rates from central banks. How to keep the patient from flipping its lid?

    August 14th, 2007 at 7:16 am

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