Investment Markets » Banking and Finance
Third Time Lucky
Central banks are pulling out all the stops to avoid market collapse. Can they succeed?
At least one thing that Alistair Darling didn't have to worry about on Budget Day was the possibility of a market crash. The situation on both sides of the Atlantic had certainly been looking precarious, with funds exposed to mortgages of any sort falling like dominos, and senior bankers reporting that illiquidity in global capital was as bad as when markets froze in August.
But on the eve of the Chancellor's Budget debut, in came the cavalry – again. In heir third major attempt to unplug the money markets, central bank plumbers – led by the US Federal Reserve – injected a further $280bn into the banking system. The markets loved it. Shares on Wall Street staged their biggest one-day rise in five years.
The rush to the exits had gathered such speed that fresh intervention from the Fed was inevitable, particularly in light of persistent rumours about a major bank failure. The question, though, is whether this move will be any more successful than the previous two attempts, which also boosted confidence – temporarily.
The Fed has improved its terms: it will now advance cash to smaller outfits as well as big banks and has extended the collateral terms to include mortgage securities – though only, note, high-quality ones. But in the end, the state of the real economy in the US will dictate where the story goes, and the fact that the Fed has now advanced $400bn within a week suggests it is worried that the plot could suddenly get out of control.
How much further do central banks have to go to support a system that is so obviously broken? Traditional supports, such as confidence in normal debt repayment, have been knocked away in a desperate dash for cash. We have not seen anything like it since the decade of the Great Depression. Melodramatic as that might sound, it is a fact.
The outlook is certainly ugly: US recession, rising corporate defaults and perhaps banks in trouble. Greek dramatists could resolve a play by lowering a god onto stage with a crane, but while the Fed's move might look like divine intervention, it cannot enter from stage left to sort out the problem.
The underlying issue is solvency not liquidity – assets are not worth what many had hopefully assumed. Tragically, the only way to a resolution will involve suffering more pain.
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