Financial Times Editorial Comment: Do not cut rates
Financial Times Editorial Comment: Do not cut rates
Copyright The Financial Times Limited 2007
Published: August 21 2007 19:20 | Last updated: August 21 2007 19:20
Credit fuels the modern economy, and if the dislocation in the money markets lasts another month or two, investment, consumption and growth in the real economy will suffer. Central banks must restore confidence, but rather than cut interest rates they should extend liquidity operations to longer matur ities, more collateral and possibly even different counterparties.
Liquidity injections by the Federal Reserve and European Central Bank have brought down overnight interest rates, but longer-term borrowing is still unusually expensive, while US Treasury bills have been trading at panic levels of below 3 per cent. It is hard to borrow using collateral not issued or guaranteed by a government. Central bank intervention has not worked so far.
This is not a recession panic, as in 1998, when the Long-Term Capital Management crisis coincided with weak economic data.
Nor is it a panic caused by serious credit losses. Defaults on US subprime mortgages are miles off a level at which triple-A bonds backed by them would suffer losses. When they do trade, the prices can be reasonable: as part of its acquisition by Kaupthing last week, the Dutch bank NIBC sold its subprime portfolio for 78 cents on the dollar.
The problem is that the bonds do not trade – the crisis is one of liquidity – and that has spread to short-term debt sold by investment vehicles that may be exposed.
The futures market expects the Fed to cut interest rates aggressively, but unless the Fed expects harm to the real economy, that policy makes little sense. It is indiscriminate and so creates moral hazard in the markets, but there is also a good chance it would not work.
The Fed has already pushed its main funds rate down well below its 5.25 per cent target, but the problem is not overnight liquidity at banks, it is perceived credit risk on three-month commercial paper. Giving cheaper money to banks might or might not change that perception.
The lenders of last resort need to find ways to get money through the traditional banking system to the markets where the trouble is. They can do so by agreeing to lend against more securities (the Bank of Canada is already accepting commercial paper); by lending for a few months rather than overnight; and possibly by dealing with off-balance-sheet vehicles directly.
There should be no handouts – lending should be at penalty interest rates – but what is needed to jump-start the credit markets is more targeted liquidity. Central banks should not crack and cut their policy rates while they have more suitable tools in the box.
Copyright The Financial Times Limited 2007
Published: August 21 2007 19:20 | Last updated: August 21 2007 19:20
Credit fuels the modern economy, and if the dislocation in the money markets lasts another month or two, investment, consumption and growth in the real economy will suffer. Central banks must restore confidence, but rather than cut interest rates they should extend liquidity operations to longer matur ities, more collateral and possibly even different counterparties.
Liquidity injections by the Federal Reserve and European Central Bank have brought down overnight interest rates, but longer-term borrowing is still unusually expensive, while US Treasury bills have been trading at panic levels of below 3 per cent. It is hard to borrow using collateral not issued or guaranteed by a government. Central bank intervention has not worked so far.
This is not a recession panic, as in 1998, when the Long-Term Capital Management crisis coincided with weak economic data.
Nor is it a panic caused by serious credit losses. Defaults on US subprime mortgages are miles off a level at which triple-A bonds backed by them would suffer losses. When they do trade, the prices can be reasonable: as part of its acquisition by Kaupthing last week, the Dutch bank NIBC sold its subprime portfolio for 78 cents on the dollar.
The problem is that the bonds do not trade – the crisis is one of liquidity – and that has spread to short-term debt sold by investment vehicles that may be exposed.
The futures market expects the Fed to cut interest rates aggressively, but unless the Fed expects harm to the real economy, that policy makes little sense. It is indiscriminate and so creates moral hazard in the markets, but there is also a good chance it would not work.
The Fed has already pushed its main funds rate down well below its 5.25 per cent target, but the problem is not overnight liquidity at banks, it is perceived credit risk on three-month commercial paper. Giving cheaper money to banks might or might not change that perception.
The lenders of last resort need to find ways to get money through the traditional banking system to the markets where the trouble is. They can do so by agreeing to lend against more securities (the Bank of Canada is already accepting commercial paper); by lending for a few months rather than overnight; and possibly by dealing with off-balance-sheet vehicles directly.
There should be no handouts – lending should be at penalty interest rates – but what is needed to jump-start the credit markets is more targeted liquidity. Central banks should not crack and cut their policy rates while they have more suitable tools in the box.
posted by Carlos T Mock at 9:22 AM
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