Bernanke, and now the entire FOMC, keep wanting things to be better than they are.
Remember last year, when the cognoscenti were aghast when the Fed chairman forecast that losses from the subprime debacle would be a mere $50 billion (at that point, the lowest private sector estimate was $100 billion) and fell in with the “subprime is contained” crowd?
Today, despite indications in money market futures and from analysts, that the liquidity crunch will be worse at the end of this year than it was last year (and it was bad enough to lead to the first round of coordinated interventions and creation of new liquidity vehicles), the Fed said its next rate move would be an increase. It doesn’t know when that might be.
Don’t hold your breath. Based on the detail on financial firm funding requirements provided in the Wall Street Journal, that move might not take place until well into 2009.
The Journal tells us that there will be a glut of financial firm refinancings between now and the end of 2009. Now of course one can argue this is no biggie, the debt matures, the parties that get the principal back have to put the money to work somewhere, so this roll is more an accounting phenomenon, since there is no net increase in outstandings.
But these refinancings are driven primarily by the maturing of floating rate notes issued in 2006. Banks looked safe then. They don’t look so safe now. Pretty much every financial institution of any size has taken a downgrade.
Many investors might have decided to sit with their 2 year paper; others may have gotten in opportunistically, finding what looked to be an attractive trade. But anyone looking at these credits now is going to be worried about the risk of further downgrades. That, plus the sheer amount of paper on offer is going to mean these deals will need to carry healthy spreads to get done.
Of course, as the article notes, financial firms could simply shrink their balance sheets. And even though that is what ultimately needs to happen (the US is overleveraged), its the last thing the Fed or Congress wants to see, since deleveraging is deflationary.
From the Wall Street Journal (hat tip reader Steve A):
U.S. and European banks, already burdened by losses and concerns about their financial health, face a new challenge: paying off hundreds of billions of dollars of debt coming due.
At issue are so-called floating-rate notes — securities used heavily by banks in 2006 to borrow money. A big chunk of those notes, which typically mature in two years, will come due over the next year or so, at a time when banks are struggling to raise fresh funds. That’s forcing banks to sell assets, compete heavily for deposits and issue expensive new debt.
The crunch will begin next month, when some $95 billion in floating-rate notes mature. J.P. Morgan Chase & Co. analyst Alex Roever estimates that financial institutions will have to pay off at least $787 billion in floating-rate notes and other medium-term obligations before the end of 2009. That’s about 43% more than they had to redeem in the previous 16 months….
As banks scramble to pay the floating-rate notes, they could see profit margins shrink as wary investors demand higher interest rates for new borrowings. They’re also likely to become less willing to make new loans to consumers and companies, aggravating economic downturns in both the U.S. and Europe.
“It’s going to be a bigger problem now than it was in the first half of this year, but it’s going to continue on for probably at least a nine-month period,” said Guy Stear, credit strategist at Société Générale SA in Paris.
By the end of this year, big banks and investment banks such as Goldman Sachs Group Inc., Merrill Lynch & Co, Morgan Stanley, Wachovia Corp., and U.K. lender HBOS PLC must each redeem more than $5 billion in floating-rate notes, according to a recent report from J.P. Morgan. Other big lenders such as General Electric Co., Wells Fargo & Co. and Italy’s UniCredit Group also face big bills in coming months, the report says.
Representatives of the banks said they’re fully able to meet their floating-rate note obligations, either because they’ve already lined up the necessary funds or because they have ample customer deposits they can tap.
The rates they’ll have to pay if they want to issue new debt will be much higher than they were back in 2006. In July 2007, the interest rates on banks’ floating-rate notes were only about 0.02 percentage point above the London interbank offered rate, or Libor, a benchmark meant to reflect the rates at which banks lend to one another. Today, that “spread” is at least two full percentage points for some banks.
As many banks compete for funds to pay off their borrowings, or sell assets to raise cash, their actions could exacerbate strains in financial markets. Banks that turn to shorter-term loans will have to renew their borrowings more frequently, increasing the risk that they won’t be able to get money when they need it….
The crunch comes as problems in the markets on which banks rely to borrow money are showing no sign of abating. In one gauge of jitters about banks’ financial health, the three-month dollar Libor remains well above expected central-bank target rates for the same period.
Even at the higher interest rates, banks are having a hard time getting cash…
At the same time, the pressures on limited resources of banks and investment banks are growing. Companies have been actively tapping bank credit lines set up before the credit crisis began…. A number of big financial firms, including Citigroup Inc., Merrill Lynch, UBS AG, Morgan Stanley, J.P. Morgan, and Wachovia, have agreed to buy back some $42 billion of so-called auction-rate securities amid allegations that they misinformed retail investors about the securities’ risks.
As we and the Journal noted earlier, the GSEs have over $225 billion to refinance by the end of September.
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Merrill Lynch & Co., Wachovia Corp., Lehman Brothers Holdings Inc. and the rest of the U.S. finance industry are about to find out how expensive credit has become.
Banks, securities firms and lenders have a record $871 billion of bonds maturing through 2009, according to JPMorgan Chase & Co., just as yields are at their most punitive compared with Treasuries. The increase in yields may cost them as much as $23 billion more in annual interest versus a year ago based on Merrill Lynch index data.
Great hits FYI: By other measures, costs for banks’ borrowing needs have also been rising. The spread between three-month Libor and overnight index swaps has been climbing since February. What’s known among credit analysts as the BOR-OIS spread gives a view of Libor that strips out expectations that central banks will raise or lower rates.
The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster by Nouriel Roubini February 5, 2008
Eleventh, the worsening credit crunch that is affecting most credit markets and credit derivative markets will lead to a dry-up of liquidity in a variety of financial markets, including otherwise very liquid derivatives markets. Another round of credit crunch in interbank markets will ensue triggered by counterparty risk, lack of trust, liquidity premia and credit risk. A variety of interbank rates – TED spreads, BOR-OIS spreads, BOT – Tbill spreads, interbank-policy rate spreads, swap spreads, VIX and other gauges ofinvestors’ risk aversion – will massively widen again. Even the easing of the liquidity crunch after massive central banks’ actions in December and January will reverse as credit concerns keep interbank spread wide in spite of further injections of liquidity by central banks. Twelfth, a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction. In illiquid market actual market prices are now even lower than the lower fundamental value that they now have given the credit problems in the economy.
An important point made in the WSJ article is the fact that SIVs were major investors in the floating-rate paper being issued by the banks. Now that banks are increasingly being forced to bring SIV assets back onto their balance sheets it should do wonders for their ability to rollover that $871 billion as it comes due.
The depth of the ponzi based financing utilized by the banks is truly astounding. Leverage piled on top of leverage. That’s what happens when you try to extend beyond the natural terminus point of a fractional reserve banking system.
As I clean up old bookmarks, this stands out here:
In the case of portfolio insurance, the models assumed that there would be sufficient liquidity to execute the waves of orders, but the human element crept in and the system locked up, creating a free fall in prices. Of course, this would seem obvious to an old time floor trader, but to an academic buried in equations and proofs, it was an overlooked factor (one of the inventors went on to argue that the insurance had worked, it was the market that failed).
http://acrinv.blogspot.com/2008/06/book-review_25.html
Yes…why assume it’s just the commercial banks it’s the i-banks as well.