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Gordon Brown did indeed save the financial system

October 20th, 2008 · No Comments

We had an earlier article, predicting that the Gordon Brown would save the world’s financial system. (We were even a day earlier than Krugman, but he might have been distracted by winning the Nobel prize in economics.) What can be concluded now is that It did. Brown’s plan is working. It cannot be exaggerated how important this plan has been. It’s hard to imagine what would have happened without it, but a total melt-down of the financial system was well and truly on the cards that week.

Things are getting better. First a little bit on the announcements, now in bigger steps on the first implementations. What’s most important though, is that things didn’t get worse, because every indicator showed that they were about to do just that. The world’s financial system could very well have been in a complete melt-down. In stead, things are normalizing (see article below).

We really owe Gordon Brown one. In Washington, they were dithering for weeks with the Paulson plan that, for very curious reasons, didn’t contain the most effective steps, infusing banks with capital (much more efficient than just buying dud assets from them) and guaranteeing inter-bank loans.

Weeks of announcements of that plan showed that it didn’t impress the markets at all. There was much criticism from academic economists (we once were one as well), and only when Brown showed the right kind of plan and Europe followed with amazing (and quite unusual) speed, the US turned it’s plan around and allowed infusions of capital into banks.

We fear that the main reason Paulson objected to this was ideological, the same reason as why we got into the financial mess in the first place. Yes, it’s a big ideological step for a supposedly ‘free-market’ government to have to take ‘socialist-like’ measures to save the financial system, but it had to be done.

And the weeks of dithering betrayed a great American tradition; pragmatism. Because the Brown plan works, as we can see here:

Libor Falls on Government Bailouts, Emergency Central Bank Cash
By Gavin Finch and Patricia Lui

  • Oct. 20 (Bloomberg) — Money-market rates fell, extending last week’s declines, as governments bailed out banks and policy makers intensified efforts to combat the freeze in lending with cash injections.
  • The London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars slid 36 basis points to 4.06 percent today, the biggest drop in nine months, according to the British Bankers’ Association. The overnight-dollar rate declined 16 basis points to 1.51 percent, the lowest level in more than four years. The three-month rate for euros fell. The Libor-OIS spread, a measure of cash availability, dropped below 300 basis points for the first time in almost two weeks.
  • The policies put in place by authorities around the world have clearly reduced the risk of more bank defaults,” said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets. “I expect interbank rates to continue to gradually decline over the coming weeks as central banks flood the market with cash.”
  • Policy makers have redoubled efforts to end the 14-month-old credit crunch that’s threatening to tip the global economy into a recession. Interbank lending evaporated after Lehman Brothers Holdings Inc. filed for bankruptcy Sept. 15, shattering confidence among lenders and sending borrowing costs to records.
  • ING Rescue
  • The difference between what banks and the U.S. Treasury pay to borrow for three months, the so-called TED spread, was 144 basis points lower today than on Oct. 10, when it reached the highest since Bloomberg began tracking the data in 1984.
  • ING Groep NV, the biggest Dutch financial-services firm, will get a 10 billion-euro ($13.4 billion) lifeline from the Dutch government after mounting credit-market losses drove the stock to a 13-year low. The government will buy non-voting preferred shares and appoint two representatives to the board, the Amsterdam-based company said yesterday. The stock surged 25 percent today.
  • European Central Bank President Jean-Claude Trichet said policy makers have put banks “on the path” to recovery by pumping unprecedented amounts of cash into money markets.
  • “I expect the banks to normalize their relationships, meaning that they start lending to each other and that they lend to their clients,” Trichet said in an interview on French radio RTL yesterday. The banking system is “on the path to normalization,” he said.
  • Hong Kong’s three-month interbank rate tumbled 53 basis points, the most in 10 years, to 3.66 percent today, after the city’s Monetary Authority injected HK$4 billion ($515 million).
  • Safe Haven
  • “We’re seeing the worst of the seizure in money markets starting to come to an end,” said Warren Hogan, head of economics at Australia & New Zealand Bank Ltd. in Sydney. “The government guarantees that have been announced globally are having an effect in the market.”
  • Though interbank rates have declined, financial institutions remain wary of lending to each other, preferring to deposit cash with central banks.
  • Banks on Oct. 17 lodged a record 239.6 billion euros in the ECB’s overnight facility at 3.25 percent. They also borrowed 14 billion euros from the ECB at the emergency overnight marginal rate of 4.25 percent, up from 13 billion euros a day earlier. The ECB’s benchmark rate is 3.75 percent.
  • The three-month dollar rate is still 256 basis points more than the Federal Reserve’s key rate of 1.5 percent, up from 120 basis points a month ago. At the start of the year, the spread was 43 basis points.
  • Commercial Paper
  • Rates for one-month commercial paper fell to a three-week low last week, with the average yields offered on the highest-rated securities placed by dealers sliding 48 basis points to 3.45 percent on Oct. 17, according to data compiled by Bloomberg. Rates dropped 83 basis points last week to the lowest level since Sept. 26. Yields reached a nine-month high of 4.28 percent on Oct. 10. A basis point is 0.01 percentage point.
  • Commercial paper is used by companies to meet short-term financing requirements.
  • South Korea will pour as much as $130 billion into its banking industry, joining governments in the U.S., Europe, Japan and Australia in shoring up banks to avoid financial gridlock.
  • The Libor-OIS spread, which measures the difference between the three-month dollar rate and the overnight indexed swap rate, narrowed 35 basis points to 295 basis points today, down from 364 basis points on Oct. 10. The rate was 24 basis points on Jan. 24, while the average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.
  • TED Spread
  • Overnight indexed swaps are over-the-counter traded derivatives in which one party agrees to pay a fixed rate in exchange for the average of a floating central-bank rate during the life of the swap. For dollar swaps, the floating rate is the daily effective federal funds rate.
  • The TED spread narrowed by 46 basis points to 317 basis points today, down from 464 basis points on Oct. 10.
  • While the reliability of the Libor-setting process has been criticized amid the global credit squeeze, it’s used to determine rates on $360 trillion of financial products worldwide, from mortgages to company loans and derivatives.
  • Libor is set by a panel of banks in a daily survey by the British Bankers’ Association by noon in London. Members provide estimates on how much it would cost to borrow in 10 currencies for terms from one day to a year. The Bank for International Settlements said in March some lenders may have “manipulated” rates to keep from appearing like they were in financial straits.
  • Hoarding Cash
  • Interbank lending rates jumped this year as banks hoarded cash after the U.S. subprime market collapsed, prompting writedowns and losses exceeding $660 billion worldwide. Funding costs eased last week after central banks around the world offered lenders unlimited amounts of U.S. currency.
  • India’s central bank unexpectedly lowered its key repurchase rate today for the first time since 2004 as the risk of an economic slowdown caused by the global financial crisis outweighed inflation pressures. The Reserve Bank of India cut its overnight lending rate to 8 percent from 9 percent, according to a statement in Mumbai.
  • The Bank of England started its new framework to provide emergency funds to banks and said it will consider revising collateral rules in the future.
  • The new framework features a discount window that allows banks to swap assets for government bonds. The new standing facility cuts the penalty for borrowing funds directly from the central bank overnight.

Tags: Credit Crisis