Apologies for the heavy reliance on the Financial Times today, but the pickings elsewhere are meager indeed.
The FT has an interesting juxtaposition of stores on its website tonight. The lead story, from the Fed’s Jackson Hole conference, reports that Bundesbank President Axel Weber described the current credit crunch as resembling a bank run, but involving non-bank actors. However, central bankers cannot address this problem directly and may have to resort to easing monetary policy instead:
The current turmoil in the financial markets has all the characteristics of a classic banking crisis, but one that is taking place outside the traditional banking sector, Axel Weber, president of the Bundesbank, said….
The comments mark the first time that a top central banker has endorsed the notion that the non-bank financial system is seeing an old-style bank run….
The Bundesbank president said that the market had completely over-reacted to the credit losses in the US subprime mortgage sector….
However, the tools that modern central banks possess to address liquidity problems can only directly address such runs inside the traditional banking sector, and do not directly touch the non-bank financial sector, which has been hardest hit by the current credit crisis.
Mr Weber’s analysis highlights the dilemma facing central banks, which cannot channel funds directly to the non-bank financial sector, and may therefore have to resort to easing monetary policy instead. The ECB is due to set its key interest rate on Thursday and the Federal Reserve on September 18.
Mr Weber told fellow central bankers and economists at the Federal Reserve’s Jackson Hole symposium that the only difference between a classic banking crisis and the turmoil under way in the markets is that the institutions most affected at the moment are conduits and investment vehicles raising funds in the commercial bond market, rather than regulated banks.
These entities were inherently vulnerable to a sudden loss of confidence on the part of their funders because “there is a maturity mismatch” on the part of financial institutions that have invested in long term mortgage-backed or asset-backed securities using short-term finance.
“Most of the conduits are owned by the banks,” he said. In many cases, sponsoring banks are being forced to take risky assets back onto their balance sheets, in turn causing banks to keep hold of their own cash, putting pressure on short-term money markets, he argued.
While the Bundesbank chief and others at the Fed conference saw a “run on the shadow banking system,” the White House cheerily maintained that things would sort themselves out on their own:
The private sector will find ways to structure debt arrangements that will ensure that most US homeowners facing big increases in their mortgage payments will stay in their homes, Ed Lazear, chairman of the White House council of economic advisers has told the Financial Times.
Mr Lazear said the administration did not believe it would be helpful to set up a government-sponsored vehicle to organise debt arrangements, which involve rescheduling or reducing payments by the borrower.
“I believe, and I think the president believes, that markets are very good at finding ways to solve problems,” he said.
Now admittedly, Weber and Lazear are addressing distinct but intertwined issues. The central bankers at Jackson Hole are discussing a global deleveraging that was set off by the US subprime crisis; Lazear is speaking more narrowly about the the subprime crisis as it affects US homeowners, and perhaps the broader US economy. And one could also argue that, since the markets are irrationally panicked, reassurance, even if it is a bit empty, is a good thing.
But the specter of the Administration hailing the virtues of the markets when those very same markets got us into this mess is an act of willful blindness. However this “do as little as possible” posture is consistent with President’s choice to announce his largely cosmetic housing program on the deadest Friday of the summer.
4 comments
Comments are closed.
Yves, of course what Axel Weber refers to as turmoil outside the traditional banking center is unwinding of leveraged positions of every stripe and of course he isn’t liking it. He can’t possibly think it all comes down to a maturity mismatch, can he?
I have no idea how much or little Ed Lazear understands of the broader context. His stated position implies a deflationary bias, and I can hardly credit the White House with subscribing to that outcome.
Nonetheless, if Weber is signaling a coordinated global CB rate reduction, then that’s novel and I’m interested to know more about it.
Burnside,
I can only go by what I saw in the FT. I looked at Bloomberg, the WSL, and Econbrowser and haven’t yet found any other reports on Weber’s remarks.
HIs maturity mismatch comment may have been mainly about SIVs, which bought long-ish dated assets, including mortgage paper, and funded them in the CP market. They are a big part of reason the ABCP paper market has dried up.
But James Hamilton raised an interesting issue: if a financial institution is too thinly capitalized and takes losses, you can also have a run:
The problem arises when the losses on the institution’s assets exceed its net equity. Short-term creditors then all have an incentive to be the first one to get their money out. If the creditors are unsure which institutions are solvent and which are not, the result of their collective actions may be to force some otherwise sound institutions to liquidate their assets at unfavorable terms, causing an otherwise solvent institution to become insolvent….
So basically, Hamilton effectively tells us that even a small maturity mismatch in the wrong market climate can still get you in trouble. Think of those hedgies who let their investors get out on 90 days notice. Now theoretically, they have liquid assets, so letting investors redeem shouldn’t be a problem. But of course, investors too often want to redeem at precisely the time when selling any assets in the foreseeable future doesn’t look so hot.
It may get back to a point raised by Kaufman: too many people have redefined “liquidity” which used to mean “cash or near cash in the bank” as “access to credit.” They weren’t expecting to liquidate assets in a pinch, but to borrow. But now that borrowing has become difficult, some are having to sell assets.
Hope that wasn’t too long winded.
I find it intriguing that Europe and especially Germany have copped a lot of the fall-out from the credit crunch. This would have nothing to do with the Euro becoming a monetary competitor (threat) to the USD, or that the German CB holds too much (according to their peers) gold.
Hamilton’s comment about the opacity of the market is very apt – no one wants to lend (unless the borrower submits to a full audit maybe ?)
The action in ABCP (maybe the “bank run” may be related to potential and actual changes in the risk weighted capital that must held against liquidity facilities as well as the drawing down of thses facilities. These can vary based on whether liquidity faciities qualify.
http://www.federalreserve.gov/boarddocs/srletters/2005/SR0513a1.pdf
And also to ratings changes.
Another question is how liquid were/are the secondary markets for ABCP and CDOs outside issuance and rollover.