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Strategies & Market Trends : Currencies and the Global Capital Markets

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To: Chip McVickar who wrote (364)	7/30/1998 11:30:00 AM
From: Henry Volquardsen	Read Replies (4) of 3536

Basically what he is referring to is the problem with hot money. The short-term interbank market is essentially wholesale money. The advantage is that it is easy to deal with and available in large quantities. The disadvantage is that it is professional money that is very tuned into what might be happening and is able to respond quickly to changes of condition. Think of two US banks that had some financial questions about them during the 80s. Bank of America and Continental Illinois. BofA was located in California and had a huge branch network throughout the state. They took in a huge amount of retail deposits. So much so that they got more money than they needed and were lending money interbank. When questions arose about their financial condition many of these depositers kept their money at BofA. Many were unaware of the troubles and those that did relied on FDIC to protect them. As a consequence BofA never suffered a liquidity crisis and survived. Continental Illinois on the other hand was in Illinois. Illinois had restrictive branching rules that severely limited their branch network. They were aggressive commercial lenders and in order to fund this lending they relied on wholesale money. They were active borrowers in the US interbank market and the euro markets. This was fine as long as there were no questions about them. However when Penn Square Bank blew up and threatened to take Conti with them the 'professional' money knew instantly and avoided them like the plaque. Since they didn't have a stable retail deposit base like BofA they were in a position where they suffered a severe liquidity crisis. The bulk of their assets were fine but they couldn't fund them at any price. Eventually it required Fed intervention. The current Japan premium is an other example of wholesale money being skittish of risky credits who are dependant on wholesale money. This has been an ongoing and legitimate concern of the Fed. Most US banks are ok on this issue as they have stable retail deposit bases. You can extend this concern on a national level by pointing to the SE Asian and other emerging economies who have gotten into trouble. They all lack insufficient domestic savings (retail deposits) to finance their growth and are dependant on professional money. Fine as long as things go well but hit a bump in the road and you get the liquidity crisises we have seen. Henry

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