from Follow the Money

The scale of central bank (and sovereign fund) intervention in global markets has been breathtaking

September 18, 2008

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I think we now know why the US Treasury is selling Treasury bills like mad to raise money for the Fed.

$180 billion is a lot of money to lend to other central banks so that they can supply dollar liquidity in their national markets. The ECB is now prepared to lend out more than $100 billion US dollars to European financial institutions:

Under the latest action plan drawn up by central bankers, the ECB said it would expand its armoury by offering “for as long as needed” $40bn in overnight funds to eurozone banks. The ECB is also expanding its reciprocal arrangements with the US Fed to increase to $25bn the amount it provides in the market for 28-day funds and $15bn over 84 days. Under the expanded plans, the amount of outstanding dollar liquidity provided by the ECB could reach as much as $110bn – compared with $50bn previously.

No doubt the Fed is financing a host of US banks and broker-dealers as well.

The Fed’s balance sheet indicates that it provided an additional $100b in direct credit to the US financial system over the last week (look at the Wednesday to Wednesday change in "other loans" rather than the change in the weekly averages) -- "Primary credit" rose by $10b, roughly $60b was drawn from the prime dealers credit facility and another $28b was provided in "other credit." Then throw in another $10b increase in the securities the Fed has lent to dealers, bringing that total to $127b. By my count -- which could be off -- the Fed has now provided around $500b in credit to the US financial sector over the last 12m months.*

And given how much has happened, that will probably be a couple hundred billion or so out of date. Or something like that.

Financial institutions have loss confidence in each other. American savers may soon lose confidence in money market funds -- a key source of financing for a host of financial institutions. That effectively leaves the Fed -- and other national central banks -- as the only institution willing to supply financing to many financial institutions. Just think how extraordinary it is for the chief economist of Goldman Sachs to say that there has been a complete loss of confidence in the markets.

"``There’s a complete lack of faith in the markets,’’ said Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London. ``There’s a lot of cash hoarding and people losing trust in banks, so the central banks are acting to relieve that. This might not be the last time they have to act.’’

The FT puts it simply in their leader.

"They have now duly become the last resort in a generalised panic in the core of the world’s financial system on a scale not seen at least since the 1930s. Nobody trusts any credit, other than that of governments themselves. In this situation, the rule is simple, clear and well-known ever since the days of Walter Bagehot. Central banks must lend freely against collateral of even borderline value. If the private sector will only lend to the government, the government must finance the private sector. It is as simple as that."

It isn’t just the G-7 banks either. Emerging market governments have been intervening heavily as well, led by Russia. $60b is a lot of money for Russia’s three big state banks. Supplying the state banks with cash allows them to lend to other banks - thus helping to address the broader squeeze -- though it hasn’t worked so far:

The finance ministry pledged to pump a further $60bn into short-term deposits in the three main state-controlled banks, however, earlier injections had failed to be transferred into the broader system as interbank lending froze.

Russia’s government is clearly going to take other steps to support its stock market as well. Its ample reserves give it a lot of options even if it is getting really squeezed by a combination of trouble in global markets (lots of Russian banks need to rollover external credit lines), falling oil prices and a self-induced rise in Russian political risk.

And a host of sovereign funds have been supporting their local equity markets. The CIC is buying shares in the big three Chinese state banks (it already owns a majority of these firms stock, so it is adding to its already large position).

There is certainly talk that the big Gulf funds should do more to support their local markets. No doubt there are other examples as well.

Such support clearly reflects a policy choice about how best to use the state’s wealth -- market stabilization is a government function. It isn’t necessarily the action of an investor motived solely by commercial considerations.

The world continues to change at an incredible pace. Just think that a few years ago, China was expected to need to privatize its big state banks in order to develop its own financial system. And today there is a possibility that the CIC will intervene not just to support China’s state banks but also to support Morgan Stanley. Rather than resulting in the privatization of China’s state banks, the current form of financial globalization could lead China’s state to take control of a paragon of American financial capitalism.

* Repos increased by around $95b, the term facility provided $150b, other credit adds in $120b (with a big increase this week), "Maiden Lane" (i.e. Bear assets) accounts for about $30b and roughly $125b of securities have been lent to dealers. If my accounting is off, please let me know. I have left out a $60b increase in the Fed’s "other assets."

** Incidentally, the Fed’s custodial holdings of Treasures and Agencies rose by $18.5b over the last week; the quiet bailout continued. Holdings of both Treasuries and Agencies increased -- with Treasury holdings rising by more.

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