Fed Injects $198 Billion Into System
Spectacular Acts Of Central Banking
Paul Maidment, 08.09.07, 9:11 PM ET Forbes
The frenzied plea of money manager turned TV markets maniac Jim Cramer to the Federal Reserve to “open the window” – i.e., pump liquidity into the banking system to forestall a credit crunch – seems to have been heard.
And it was heard as far away as Europe. Not that surprising, as Cramer was shouting loud enough.
On Thursday, the European Central Bank stunned investors by pumping $130 billion into the banking system via a tender offer taken up by 49 banks, making the Fed's action later on look modest by comparison. It injected $24 billion via overnight and 14-day repos during Thursday morning trading.
In truth, the central banks were listening more to the silent evaporation of liquidity from the inter-bank market than to Cramer, whose hysterical performance has been immortalized on YouTube. The ECB's action followed a sharp rise in overnight interest rates to 4.7%. Its target rate is 4%. In the U.S., overnight rates topped 5.75%. The federal funds target rate is 5.25%.
On both continents, the credit crunch has been caused by fears about securities related to U.S subprime mortgages that have become difficult to price in illiquid markets, and as a result, make it near impossible for investors to asses how much exposure funds and institutions have to subprime markets.
In such "who-the-hell-knows" conditions, equity, fixed income and foreign-exchange markets, all linked by a web of derivatives, become as volatile as we have seen in recent weeks. Only commodity markets seem immune.
The ECB's intervention was not far short of what it did in the two days following the 9/11 attacks on New York and Washington, D.C., in 2001. And it was 10 times the size of a typical ECB intervention, compared with the Fed's twice normal.
The relative scale of the two central banks actions prompts two thoughts. One should calm investors' jitters, if not the other.
The first is that the Fed believes that U.S. credit markets are still functioning adequately, if somewhat creakily, and that there is no crisis at hand. That is consistent with its comments just two days earlier when the Fed's interest rate-setting committee met, after which the Fed said nothing to suggest that the increasing number of banks and funds 'fessing up to subprime woes posed any sort of systemic risk to the financial system.
The second, as some commercial bankers have publicly acknowledged, is that the ECB pulled off a spectacular act of central banking by dint of the very scale of its intervention, pushing overnight rates back down to 4.1%.
But there is a second thought to that second thought. In taking such sweeping action, the ECB may have sent a signal to investors that there could be worse still to come, that the BNP Paribas (other-otc: BNPQY - news - people ) scare is only the tip of an iceberg. And that the ECB may know more that it is letting on. So, too, may the 49 banks who took its $130 billion on Thursday.
Unknown unknowns, to borrow former U.S. Defense Secretary Donald Rumsfeld's parlance, scare investors like nothing else.
And from the BBC
Are global market bubbles set to blow?
By Ben Richardson
Business reporter, BBC News
How can you tell the difference between a boom and a bubble?more here
There is a strange fascination in blowing a bubble, when despite your better judgement, you keep willing it to get bigger regardless of the dangers.
Then, suddenly, the violent pop that leaves you picking bubblegum off your eyebrows, or crying soapy tears.
For many observers, global markets are getting dangerously close to such a bursting point.
Until recently, we have been living in a period of low global interest rates that have let consumers and companies borrow money cheaply.
That has driven demand for mortgages, let companies pay increasingly large sums for takeovers, and allowed consumers to spend freely.
And the results of this credit splurge are hard to ignore:
UK house prices have doubled in the past 10 years.
China's main stock index has quadrupled in value since the start of 2006.
The UK's FTSE 100 and US S&P 500 stock indexes are at levels not seen in almost seven years.
Commodity prices have been buoyed by strong global demand, pushing some such as copper to records.
Merger and acquisition activity has taken off, and private equity firms are now in control of some of the world's biggest brands.
But as the records have continued to tumble, concerns have kept on mounting.