The coordinated 0.5 per cent rate cut announced overnight, including even the European Central Bank, was a good start. It has helped settle markets, but it is not enough.
The world’s politicians need to join in the coordination.
That’s because the interest rates that businesses pay for credit have disconnected from official cash rates and now have more to do with levels of bank capital rather than cost of funds.
And the global pool of bank capital is under such threat that its future now lies in the hands of governments — they are the only entities capable of recapitalising the banking system.
But they appear to be too weak, paralysed by politics or confused about what to do. In any event, the world’s politicians are uncoordinated and applying a wide variety of different coloured band-aids to the financial system.
Last night three month Libor, which forms the base of most business and interbank lending, actually went up 20 basis points to 4.5 per cent. Overnight Libor rose to 5.38 per cent on Wednesday from 3.94 per cent on Tuesday, so while it should come back now that official overnight rates have been eased, it is from a higher base.
Meanwhile in the United States, the interest rate on A2 rated commercial paper — that is, what the run-of-the-mill corporate borrower pays — was 5.4 per cent, 20 basis points higher than a year ago, despite the fact that the Fed funds rate had, at that point, come down by 250 basis points in 12 months and 325 points since before the crisis began.
Another 50 basis points off the Fed funds rate now is unlikely to make much difference to commercial paper in the current environment.
That said, the fact that global central banks have finally mounted a coordinated monetary policy attack on the crisis to supplement the liquidity measures they have been taking is a good thing, and provides the best chance for six months (since the Bear Stearns bailout) that the sharemarket will form at least a temporary bottom.
Sharemarkets usually bottom a couple months after official interest rates start coming down.
Given the astonishing collapse in both equity and credit markets since the demise of Lehman Brothers a month ago, and something resembling a ‘day of no hope’ yesterday, especially in Japan, there is good reason to expect a solid rally to come out of the global monetary easing.
The reason that might not happen was spelled out in last night’s new World Economic Outlook from the IMF.
The IMF has reduced its baseline world growth forecast for 2009 from 3.9 to 3 per cent but has acknowledged “substantial downside risks” to that.
They are (it won’t surprise you to learn): “…that financial stress could remain very high and that credit constraints from deleveraging could be deeper and more protracted than envisaged in the baseline. In addition, the U.S. housing market deterioration could be deeper and more prolonged than forecast, while European housing markets could weaken more broadly.”
The IMF assumes that actions by the authorities in Europe and the US will succeed in stabilising conditions and avoiding further systemic events, but it can’t be sure.
And even on that basis “additional credit losses are likely as the global economy decelerates”.
“In this setting, financial institutions’ ability to raise new capital will remain very challenged. The required deleveraging will be a protracted process, implying that limits on the pace of credit creation — and on activity — will be present through 2009.”
There is absolutely no reason to doubt this. If Iceland defaults, which seems likely, and/or the UK government bailout fails to prevent at least one significant bank collapse (£25 billion in equity won’t go very far), and/or Russia gets into strife (actually it’s already there — its stockmarket fell 11 per cent yesterday before being closed) then the deleveraging will be very protracted indeed.
Central banks have done what they can; it is now up to the politicians.
In his latest blog for Euro Intelligence the Financial Times columnist Wolfgang Munchau lambasts the US and European governments for their mistakes in handling the crisis.
He asserts that US Treasury Secretary Henry Paulson’s $US700 billion bailout was the “most expensive and unfairest” way to recapitalise the banking system, and was purely designed to help Goldman Sachs, and he says the German government’s policy consists of a bet that the public will remain “infinitely stupid” — a bet it will lose.
That’s because it is wasting its resources on second rate institutions like Hypo Real Estate, so that its freedom of manoeuvre will be constrained “if or when” it is time to save Deutsche Bank or Allianz.
If he’s half right, the coordinated global central bank actions last night need to be supplemented by a coordinated, global bank recapitalisation.
As Business Spectator’s interview with Reserve Bank assistant governor Guy Debelle last week showed, central bankers are talking to each other every day, swapping information as well as cash and agreeing on what to do.
Little sign of that among the politicians: it is every man and women for themselves.