Gordon Brown’s plan is working, confidence is returning

This really is good news. We were due for some. Gordon Brown, prime minister of the UK, architected a three pronged approach to the financial crisis. Europe followed pretty fast, and the US, which plan didn’t bring any results, also finally followed. We start to see the first glimpses of confidence returning in the inter-bank money market.

Those three legs of the Brown plan are:

  1. Provide liquidity
  2. Recapitalize the banks
  3. Guarantee all inter-bank loans.

The US plan basically limited itself to the first step only, and that was clearly not enough. With most of the world now adopting Brown’s strategy, we are starting to see results.

How do we know:

  • inter-bank interest rates, for instance the most important one Libor, are falling, a sign of increased inter-bank confidence
  • the difference of inter-bank rates and three months treasury returns (a safe haven investment), the TED spread, is also falling

Dollar Libor Logs First Weekly Drop Since July on Cash Funding
By Gavin Finch and Candice Zachariahs

  • Oct. 17 (Bloomberg) — The cost of borrowing dollars in London fell, capping the first weekly decline since July, after central banks around the world pumped unprecedented amounts of cash into money markets and governments backed loans.
  • The London interbank offered rate, or Libor, for three- month loans in dollars dropped for a fifth day, sliding 8 basis points to 4.42 percent, the British Bankers’ Association said. It declined 40 basis points this week. The overnight rate for dollars slid 27 basis points to 1.67 percent, the lowest level since September 2004. Asian rates also fell.
  • “Libor rates continue to edge down, bringing the prospect of some rejuvenated interbank lending that little bit closer, even if it is still some way distant,” said Daragh Maher, deputy head of global currency strategy in London at Calyon, the investment-banking arm of French lender Credit Agricole SA.
  • Rates fell this week after central banks joined forces to offer lenders an unlimited supply of dollars and the European Central Bank did the same with euros. Still, the cost of borrowing between banks remains near record highs relative to the Federal Reserve’s benchmark rate of 1.5 percent.
  • The spread between three-month dollar Libor and the Fed rate was 292 basis points, or 2.92 percentage points, up from 108 basis points a month ago. At the start of the year, the spread was 43 basis points.
  • “Money-market rates are slowly improving, though the glacial pace is a bit of a concern,” said Adam Carr, senior economist in Sydney at ICAP Australia Ltd., a unit of the world’s largest inter-bank broker.
  • Rate Bets
  • Futures traded on the Chicago Board of Trade show a 48 percent chance the Fed will cut the target rate for overnight bank loans by 50 basis points at its Oct. 29 meeting. The odds were zero a week ago. The chances of a 25 basis-point reduction are also 52 percent, from 72 percent a week earlier.
  • 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 at about noon in London. Members provide estimates on how much it would cost to borrow in 10 currencies for terms from a 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.
  • Asia Declines
  • In a further sign the freeze in credit markets may be thawing, institutions deposited less cash with the ECB overnight, the central bank said today. Banks lodged 205 billion euros ($276.4 billion) at 3.25 percent, down from a record 210.8 billion euros on Oct. 15. The daily average in the first eight month of this year was 425 million euros.
  • Money-market rates fell in Asia today. Hong Kong’s three- month dollar price slid 15 basis points to 4.2 percent, the biggest drop in three weeks. Japan’s one-month deposit rate dropped 25 basis points to 1.1 percent, heading for the biggest weekly decline since 2000.
  • “The market is starting to believe that central banks’ policy actions are taking out some of the financial systemic risk,” said Craig Saalmann, a Sydney-based credit strategist with JPMorgan Chase & Co.
  • Lending between banks, which slumped after the collapse of the U.S. subprime-mortgage market last year, all but seized up after Lehman Brothers Holdings Inc. went bankrupt Sept. 15.
  • Libor-OIS Spread
  • The Libor-OIS spread, which measures the difference between the three-month dollar rate and the overnight indexed swap rate, was at 332 basis points today, up from 24 basis points on Jan. 24. The average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.
  • 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 difference between what banks and the Treasury pay to borrow money, the so-called TED spread, fell to 397 basis points today, down from the 464 basis points it reached on Oct. 10, the most since Bloomberg began tracking the data in 1984.