~~~ ~~~ ~~~
Business Times – 11 Mar 2008LAST Friday’s employment report – which was so weak that it had many economists declaring that the US is already in a recession – was bad news.
But it was actually less disturbing than what’s going on in the financial markets. The scariest thing I’ve read recently is a speech given last week by Tim Geithner, the president of the Federal Reserve Bank of New York. Mr Geithner came as close as a Fed official can to saying that the US is in the midst of a financial meltdown.
To understand the gravity of the situation, you have to know what the Fed did last summer, and again last fall. As late as August, the favourite buzzword of financial officials was ‘contained’: problems in sub-prime mortgages, we were assured, wouldn’t spread to other financial markets or to the economy as a whole. Soon afterwards, however, a full-fledged financial panic began.
Investors pulled hundreds of billions of dollars out of asset-backed commercial paper, a littleknown but important market that has taken over a lot of the work banks used to do. This de facto bank run sent shock waves through the financial system. The Fed responded by rushing money to banks, and markets partially calmed down, for a little while. But by December the panic was back.
Again, the Fed responded by rushing money to banks, this time via a new arrangement called the Term Auction Facility. Again, the markets calmed down, for a while. But again, the respite was only temporary. Last month, another market you’ve never heard of, the US$300 billion market for auction-rate securities (don’t ask), suffered the equivalent of a bank run.
Last week, two big financial companies announced that they had been unable to raise the cash demanded by their lenders. Even Fannie Mae and Freddie Mac, the giant US government-sponsored mortgage agencies long regarded as safe places to put your money, are now having trouble attracting funds.
One consequence of the crisis is that while the Fed has been cutting the interest rate it controls – the so-called Fed funds rate – the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that’s sure to worsen the economic downturn.
What’s going on? Mr Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing ’significant collateral damage to market functioning’. A report released last Friday by JPMorgan Chase was even more blunt. It described what’s happening as a ’systemic margin call’, in which the whole financial system is facing demands to come up with cash it doesn’t have. The Fed’s latest plan to break this vicious circle is – as the financial website interfluidity.com cruelly but accurately describes it – to turn itself into Wall Street’s pawnbroker.
Banks that might have raised cash by selling assets will be encouraged, instead, to borrow money from the Fed, using the assets as collateral. In a worst-case scenario, the Federal Reserve would find itself owning around US$200 billion worth of mortgage-backed securities. Some observers worry that the Fed is taking over the banks’ financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: US$200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down – there are US$11 trillion in US mortgages outstanding – it’s a drop in the bucket.
The only way the Fed’s action could work is through the slap-in-the-face effect: by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past. But slap-in-the-face only works if the market’s problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice, only to see the financial crisis come roaring back, that’s hard to believe.
The third time could be the charm. But I doubt it. Soon, we’ll probably have to do something real about reducing the risks investors face.
A plan to restore the credibility of municipal bond insurance would be a start (how crazy is it that New York State, rather than the federal government, is taking the lead here?). I also suspect that the feds will have to get explicit about guaranteeing the debt of Fannie and Freddie, which really are too big to fail.
Nobody wants to put taxpayers on the hook for the financial industry’s follies; we can all hope that, in the end, a bailout won’t be necessary. But hope is not a plan. — NYT
THE Government of Singapore Investment Corp (GIC) is prepared to adjust the terms of its deal to buy 9 per cent of UBS to help the Swiss bank win shareholder approval, GIC deputy chairman Tony Tan was quoted as saying yesterday.
UBS, Europe’s hardest-hit bank from the credit crisis, received a lifeline of 13 billion Swiss francs (S$17.1 billion) from GIC and an undisclosed Middle East investor in December to shore up capital hurt by hefty United States sub-prime housing losses.
Under the deal, UBS will pay GIC – which will invest 11 billion Swiss francs – and the Middle East investor a coupon of 9 per cent on securities that can be converted into shares within approximately two years of the issue of the notes.
However, the terms of the deal have drawn ire from some smaller shareholders who said it is unfair that they cannot participate in the mandatory convertible bond, with some calling for a rejection of the deal.
‘We would be prepared to adjust the terms,’ Dr Tan said, according to the transcript of his interview with the Financial Times in Davos.
‘We would be prepared to see how we could help them. But we have signed an agreement with them so that has to be honoured.’ UBS has scheduled an extraordinary general meeting for Feb 27, when it will seek approval for the investment.
Source: REUTERS (The Straits Times 5 Feb 08)
