Jawboning is free.
Central Banks Get Creative
Some Unusual Remedies
Are Considered to Fix
Liquidity Problems
By JUSTIN LAHART
December 1, 2007; Page B1
Banks and other financial firms' persistent reluctance to lend to one another is creating a logjam in the credit markets that is pushing central bankers to get creative.
On Monday, the Federal Reserve said it would extend loans for longer-than-usual terms to Wall Street dealers it deals with directly. On Tuesday, the Bank of England said that beginning this coming week it will offer £10 billion ($20.61 billion) in special loans for five weeks at its key interest rate of 5.75%.
On Thursday, the European Central Bank said it will double the length of the one-week loans to the banking system that it will disburse in mid-December to two weeks. That means banks can hold on to the funds through the turn of the year, a move reminiscent of the steps the ECB took in 1999 to head off financial-market turmoil in advance of the millennial changeover and possible Y2K bugs.
But all this did little to soothe financial institutions' nerves. Indeed, the London interbank offered rate charged by banks for short-term loans to one another actually rose last week.
The question now: What else can central banks do?
Fed officials are actively considering a variety of conventional -- and unconventional -- steps to improve credit conditions, though they haven't revealed specifics.
The simplest option would be to lower their target rates for the overnight loans that banks make to each other, as the Bank of Canada and Bank of England may do in the coming week and most analysts now expect the Fed to do on Dec. 11. Yet credit-market troubles linger and banks continue to hoard cash even though the Fed already has cut its target for the key federal-funds interest rate (at which banks lend to each other overnight) to 4.5% from 5.25%.
Another Discount-Rate Cut?
The 21 banks and broker-dealers that the Fed deals directly with "are probably unwilling to distribute reserves as effectively as in the past," says American Enterprise Institute economist Vincent Reinhart, who until this year directed the Fed's monetary affairs division.
Another option for the Fed would be to lower the rates it charges for loans it makes directly to banks from its discount window. In August, the Fed brought the discount rate down from a full percentage point above the fed-funds rate to just 0.50 percentage point ahove it. But banks haven't borrowed much there, perhaps because the discount window still carries a stigma that tapping it is a struggling bank's last resort.
A lower discount rate might help, and could be an important signal to market participants that other financial firms they do business with will have access to funds if they run into trouble. "Just as a German shepherd can be a good guard dog even if it never bites anyone, the discount window does not need to be used to improve market liquidity," Bank of America bond-market strategist Michael Cloherty said in a note to clients.
Year-end Nailbiter
One reason credit conditions may have been tight in recent weeks is that four firms -- Bear Stearns, Morgan Stanley, Lehman Brothers Holdings and Goldman Sachs Group -- ended their fiscal years on Friday, and they may be eager to make their year-end books look better. If so, credit conditions soon could improve in the coming week. But most firms end their fiscal years at Dec. 31.
"The year-end just keeps becoming more of a nail-biter," says Lou Crandall, chief economist at Wrightson Associates.
To forestall a year-end crunch, the Fed could temporarily relax banks' capital ratio requirements -- though banks might fear an adverse reaction from markets. One option would be for the Fed to persuade banks, as a group, to lower their capital ratios.
Try an Auction?
Another possibility would be for the Fed to "auction" off credit at the discount window, rather than lending from it directly to banks. Because the resulting rate would be set by the market, that might remove some of the stigma of direct borrowing. The Fed could also, as part of its regular dealings with brokers, accept slightly riskier forms of collateral to make markets more liquid.
Of course, jawboning is always a big part of the central banker's arsenal. In speeches this past week, both Fed Chairman Ben Bernanke and Vice Chairman Donald Kohn underscored the Fed's concerns about credit markets, a clear sign that they are not complacent.
"I think you're going to see lots of speeches that the Fed stands prepared, that they're ready to move," says economist Mark Gertler of New York University, who has collaborated in the past on academic work with Mr. Bernanke. |
