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Thread: Liquidity injections

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    just me duncan drennan's Avatar
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    Liquidity injections

    Last week Thursday and Friday a large amount of cash was injected into the world's banking systems by the US Fed, and also other reserve banks around the world (including Europe, Japan, Australia and Canada). See this article, and many others if you search around the web.

    I don't really understand the reasoning behind these moves, could someone explain why they central banks decided that now was a good time to inject a bunch of cash into the system?
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    Site Caretaker Dave A's Avatar
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    I think they're trying to avert a full blown global recession.

    There has been a massive disruption of the status quo in financial markets as the knock-on effects of "junk bond" defaults start to be felt. Dumping money into the markets is something of a shock-absorber that hopefully will reduce the extent of the damage. The over-extended are in trouble, plain and simple. But they are going to take a lot of viable victims with them if there is not some sort of intervention.

    The other option would be to reduce interest rates to reduce defaults, but whilst this would move the line of the over-extended, it would also be massively inflationary and quite possibly not turn the tide of rampant credit extension to those who can't leverage it into a value-add under current conditions.
    The trouble with opportunity is it normally comes dressed up as work.

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    just me duncan drennan's Avatar
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    I just don't really understand the mechanism by which this works, but I also don't really understand the actual problem properly.

    Anyone care to explain what exactly the sub-prime issue is?
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    Site Caretaker Dave A's Avatar
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    There are multiple mechanisms at work. This is a rather simplistic look at the trigger problem.

    Basically sub-prime refers to the bond or home loan market. Particularly the more marginal end. As interest rates have increased, affordability issues have kicked in and large chunks of home owners have been defaulting on their payments. With the prospect of wholesale repossessions in the offing, there is also an impact on the underlying value of property, which places a big chunk of debt inadequately secured. This starts hurting the lenders, and enough default by their clients will lead to default on the lenders' obligations - something of a domino effect.

    The weight of numbers now defaulting starts bringing down bigger entities, which in turn can hurt even bigger players (which was when the equity markets started their slide). Just who is going to be taken out at this next level becomes less predictable.

    So, the options are to take pressure off the base (the defaulting homeowners) by taking interest rates down, or to try to make sure that the next line up can ride the hit by having access to credit whilst they fend off the damage and make moves to recover their footing without bringing down those around them.

    Of course, the equity slide brings in its own new set of problems...

    Normally a stone thrown into the pond produces ripples that gradually diminish in effect the further from the source. But when everyone is heavily geared with debt and the stone is big enough, the ripples grow in effect instead of diminishing.
    Last edited by Dave A; 18-Aug-07 at 08:11 PM.
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    Silver Member Graeme's Avatar
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    For "inject" read "made available" (for banks to borrow from the Fed). The thunder storm is nearly overhead.
    Last edited by Graeme; 18-Aug-07 at 07:32 PM.

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    Site Caretaker Dave A's Avatar
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    Perhaps liquidity alone just isn't expected to be enough.
    In a bold bid to turn back a rising financial storm, the United States Federal Reserve on Friday cut a key bank lending rate and signalled a willingness to take more dramatic action to cushion the economy from tightening credit.

    With stock markets from Asia to New York reeling as shock waves from rising US mortgage defaults spread around the globe, the US central bank tried to calm financial markets by lowering the discount rate that governs Fed loans to banks by a hefty half-percentage point to 5,75%.

    While it held the benchmark federal funds rate -- its main economic policy lever -- steady at 5,25%, the Fed said it stands ready to act to keep the US economy on an even keel and many economists said rates will soon move lower.

    "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the Fed said in a rare statement issued between regularly scheduled meetings.
    full story from M&G here
    The trouble with opportunity is it normally comes dressed up as work.

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    just me duncan drennan's Avatar
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    I read this in the Sunday Times which helped me to understand it a bit better (I like the term Ninja borrowers)

    # Mortgage providers in the US offered loans to “sub-prime” borrowers — so-called because their poor credit history would not normally allow them to qualify for loans.

    # With the steady rise in US interest rates, these “Ninja” borrowers (No Income, No Job or Assets) have quickly reached their limits of affordability and so have begun to default on their loans.

    # Investors have been caught short because the mortgage firms packaged their risky sub-prime loans into products which they then sold to institutions around the world.

    # As the Ninjas default on their debt, the problems have cascaded up the food chain. US lending institutions are under threat as they are burdened with non-performing assets.

    Hedge funds are faced with enormous losses and investors have rushed for the exits. This is compounded by institutions’ sudden unwillingness to lend more money to clients.

    # Central banks have been forced to open their vaults to the big banks — lending money “overnight” at reasonable interest rates — to allow banks to meet their repayment obligations. However, too much liquid cash in the system inevitably devalues the currency and in its worst case leads to spiraling inflation and a stagnant economy: the dreaded “stagflation”.

    # For now, global stock markets remain in long-term up trends. However, particularly in the UK, Europe and Japan, investors have been bailing out.

    The appetite for all risky investments is dying. Stocks are regarded as high-risk — and stocks in emerging markets such as SA are even more risky.

    Selling by foreigner investors partly explains why the rand weakened so quickly this week.

    Full article on The Times
    The thing that worries me is that injecting liquidity just seems like it is delaying the inevitable. If the wind is blowing through a house of cards it is going to take some fancy footwork to keep everything standing (which is a chilling thought). The real problem here is that the whole world has bought into this via various financial products. Ouch.
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    Site Caretaker Dave A's Avatar
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    I think this story adds to the overall perspective.
    Global turmoil aftershocks in store
    Finance chiefs from the world's three biggest economies yesterday tried to keep a lid on credit jitters, but US treasury secretary Henry Paulson admitted that global financial turmoil would take time to play out.

    Japanese finance minister Koji Omi and Paulson agreed to keep a close eye on markets, while German finance minister Peer Steinbrueck said there was little sign of the wider economy suffering.

    Paulson said financial markets would settle down but only after a necessary period of repricing risk. "Credit is being repriced, reassessed across our capital markets," he told CNBC television. "This will play out over time and liquidity will return to normal when … investors have a better understanding of the risk-return trade-off."

    The chief executive of Germany's WestLB bank, Alexander Stuhlmann, said big problems in the US subprime mortgage market were making it difficult for German banks to get credit lines from their foreign partners.

    Stuhlmann told reporters that German banks were in a "not uncritical situation" overall. WestLB has more than €1.2 billion (R12 billion) in overall exposure to the US subprime sector - those loans extended to mainly poor people with weak credit histories.

    His assessment followed an announcement from Capital One Financial that it would cut 1 900 jobs and shut down a wholesale mortgage unit it acquired less than a year ago.

    Omi said there were no plans for an emergency meeting of the Group of Seven industrialised nations following sharp gyrations in global markets.

    Omi and Paulson agreed to keep a close watch on markets and stay in close contact.
    full story from Business Report here
    One of the positives out of all this is that there seems to be good communication between the major players and clear signs of a commitment to work together through the challenges.
    The trouble with opportunity is it normally comes dressed up as work.

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    just me duncan drennan's Avatar
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    Cees Bruggeman's (FNB's chief economist) view on this whole thing,

    Up till early this year I had never heard of US subprime lending. On hearing the detail, it left me with a sense of wonderment.

    You mean, the borrower lies about his income (no job, no income, no hope) and the lender offers exceptionally low 'teaser' interest rates, with the proviso of these going up by half (!) within two years?

    And nobody screamed?

    And then they took such loans, bundled them with better loans, sliced and spliced the end result like so much rope, got rating agencies to apply the last rites, and sold them on to unsuspecting institutions looking for yield enhancement (a little extra margin, magnified sixteen times by leveraging, so that anything small really started to look impressively large)?

    And that house of cards was supposed to remain intact?

    If you have never tasted snake-oil before, this was your golden opportunity.

    About a $1 trillion of the stuff was written, first Fed estimates are that $100bn will go bad, but add the misadventure of any misguided leveraging, and the final bill will be about $250bn.

    That would have sunk the US banking system. But because banks securitized and offloaded the stuff faster than they generated it, relatively little stuck to banks, except to the extent that their asset management funds invested in such stuff.

    Anyway, the $250bn is spread around the world, at least 10% in Japan, a goodly portion in Europe and a fair amount in lower Manhattan. The losses will rest where they fall. Rest in peace.

    Read the full article on FNB Economics
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