There is one good thing about the plan hatched by central banks last week to save the financial system from a downward spiralling crisis. The banks who will benefit from the plan, banks such as…well that’s just it. We don’t know who the banks are. Shhhh, it’s a secret.
When the Bank of England tried to pump money into the system during the autumn, the UK’s banks took one look at the money they were being offered, and said, “Thank you very much Mr Banker, but no deal.”
It wasn’t that they didn’t want the money. It wasn’t even that they weren’t prepared to pay the extra interest payments the central bank was charging. No, the problem was this: they didn’t want to admit they wanted the money in the full glare of the media’s spotlight. Why was that? Well, perhaps they were worried the Bank of England, when dishing out the readies, would say something like, “don’t panic, the bank we are lending to is solvent.”
Yesterday, the Fed unleashed the hounds of promise, or dollars as they are also called. $20 billion of them found their way onto the markets. And in the UK, the LIBOR rate, that’s the interest rate determined by markets, and which we hear so much about these days, fell. At around 6.4 per cent, down from 6.6 per cent, it’s still way above the official bank rate of 5.5 per cent, but at least it’s moving in the right direction. It doesn’t really matter if it takes a week or even two weeks for the money markets to find a level more conducive to the flow of money, as long as they get there eventually.
Today, the Bank of England, ECB and Swiss National Bank will be doing their bit, with the UK’s central bank dishing out £10 billion.
Will the central banks’ plan do the trick? Or will interbank rates start moving back up again after a few days?
It depends on whether you think this whole crisis is just about confidence, about a simple misunderstanding between banks who are not sure who they can safely lend money to when, in fact, all is fine, or whether the problems really are deeper than that.
The bottom line is that the financial crisis has been caused by excess lending. That clever little wheeze called Collateralized Debt Obligations, seemed like such a good idea. You make a risky loan, but reduce your own exposure by slicing the loan into chunks and selling it on.
That’s fine if it’s a one-off. If there is, say, a one-in-ten chance the loan will go bad, and you sell it on to, say, nine more companies, each with a similar stake in the loan as you, then if the loan goes bad you are only going to take a hit equating to 1 per cent of the total.
But supposing those nice little odds persuade you to make more loans; supposing you also buy chunks of loans off others too. Supposing that for every £1 you lend and split up into say 10p chunks, you buy nine 10p chunks from other banks. Then, if failure occurs across the board, your total hit is just as bad as it would have been if you had sold the loans on.
The danger is that the option to provide CDOs, lulled you into a false sense of security, encouraging you to make loans you wouldn’t have otherwise considered.
If the current crisis is simply down to lack of confidence based on ignorance, then the move from the central banks will help.
But if the problem is deeper than that, then the only silver bullet that can possibly come to aid, is the natural business cycle.
The recent levels of surging lending can really only be justified if you take into account rising productivity levels. In the UK, our productivity improvements still lag behind our main competitors, and that is the problem that really needs fixing.
Analysts, commentators and economists, can call out for central banks to slash interest rates, they can plea with the government to do more to help, they can even howl at the moon if they want, but unless the underlying problem is fixed, any other action taken will be little more effective than firing a spitwad at a major battle tank.
