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No sub-prime miracle cure, says OECD chief economist

Increased scrutiny; borrower education; pugnacious rating analysis needed

(MADRID) The surge in short-term rates caused by rising defaults of US sub-prime mortgages exposed ‘serious imperfections’ in the way global credit and housing markets function, OECD chief economist Jean-Philipe Cotis said.

‘Recent developments have revealed serious imperfections in the functioning of US housing markets and, more broadly, in credit markets worldwide,’ said Mr Cotis, chief economist at the Organisation for Economic Cooperation and Development.

Mr Cotis suggested that increased supervision of US sub-prime mortgages, more information and education for borrowers, and more ‘pugnacious’ analysis from credit rating companies, may help avoid future losses of confidence.

‘More transparency also seems to be called for in credit markets,’ Mr Cotis said. ‘I don’t think there’s a miracle cure readily available.’

Some so-called asset-backed securities lost more than 50 per cent before credit agencies downgraded them in July.

US Senate Banking Committee chairman Christopher Dodd said last month that the rating agencies’ failure to act sooner caused ‘great damage’.

Meanwhile, the Dutch central bank said that uncertainty has risen in the Netherlands’s financial system over the past six months and the full impact of the recent increase in borrowing costs ‘cannot be determined’.

The outlook for the financial system depends on ‘the extent to which the decreasing risk tolerance among investors continues and how much farther it spreads’, the central bank said in a report issued yesterday.

The European Central Bank and other monetary authorities around the world injected more than US$350 billion into money markets last month to prevent a wider crisis as investors shunned assets linked to US mortgages and corporate borrowing costs rose.

The US sub-prime meltdown has revealed that ‘unfavourable developments in one segment could lead to an overall deterioration of the market climate’, the Dutch central bank said. The ‘direct exposures’ of Dutch financial service companies to the sub-prime mortgage market are ‘relatively limited’, according to the report.

Meanwhile, tight money markets showed no sign of let-up in a liquidity squeeze caused by banks clamming up on lending over the past month as they scrambled to calculate exposure to mass defaults in the US sub-prime mortgage market.

Australia held interest rates steady yesterday, the first piece in a monetary jigsaw which investors expect to show euro zone policy on hold and a US rate cut in response to a global credit crisis.

Overnight interbank lending rates in the euro zone approached six-year highs, after Tuesday’s injection of liquidity by the ECB failed to sate demand for ready cash.

‘The fact that overnight is trading so high at the moment shows that the cash is not spreading out across the system, there are institutions which are struggling to get short-term needs filled,’ said a euro zone trader.

In Britain, sterling three-month money rates hit fresh 81/2-year peaks. The Bank of England – which has stood back until now – decided to act, but focused on overnight rates.

The BOE raised its aggregate reserves target for the next month by 6 per cent and said that it stood ready to add 25 per cent more if overnight interest rates stayed high.

It said that it aimed to ‘relieve some pressure on interest rates for overnight borrowing which have, at times during the maintenance period over the past month, been unusually high’.

The Reserve Bank of Australia does not explain its reasoning when leaving interest rates steady but has been striving daily to add liquidity to the banking system as market rates climbed.

The Bank of Canada was expected to follow Australia’s example late yesterday, and the European Central Bank and the BOE are seen keeping rates on hold today, while the calming of market turmoil depends overwhelmingly on the delivery of an expected Federal Reserve rate cut on Sept 18.

The Fed is expected to cut rates at its meeting after chairman Ben Bernanke said last week that he would take any steps needed to shelter the economy from the credit squeeze.

Richmond Fed president Jeffrey Lacker said on Tuesday that he would back a rate cut if the evidence showed slowing growth and lower inflation, but said that the case was not yet made.

‘If evidence arrives that we need a policy move, of course I will consider it and I will take that evidence seriously,’ he said.

‘That evidence would be of the nature of information that alters the outlook for real spending and inflation.’

Further diagnosis of the US economy will be provided later by the Fed’s Beige Book on regional economic conditions, while tomorrow’s August non-farm payrolls figures loom large.


Source: Bloomberg, Reuters (Business Times 6 Sept 07)

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