Worst crisis for 20 years, say banksDavid Smith and John Waples LEADING bankers are warning of the worst crisis in the money markets for 20 years, which will come to a head this week when $113 billion (£57 billion) of commercial paper – market IOUs – comes up for refinancing.
This huge refinancing, mainly through London, exceeds the $100 billion that became due in mid-August, and which sparked the most serious phase in the money-market crisis, which has seen banks scrambling for funds and market interest rates rising sharply. “This is a serious pressure point,” said one leading banker.
Another senior executive of one of Britain’s top five retail banks said: “These are the worst conditions I have seen in money markets for 20 years”.
The huge amount of commercial paper becoming due is the hangover from the crisis in credit markets that began with American sub-prime mortgages. Many of the off-balance-sheet structured investment vehicles (SIVs) set up by the banks were borrowed in the form of asset-backed commercial paper.
Related Links Problems are on scale of Great Depression America is facing housing crisis, UK next Now, even if they succeed in rolling over some of this paper this week, they will eventually be forced to take some of it – much of which is of questionable value – onto their balance sheets. To meet this potential liability, banks are hoarding cash and have stopped lending to each other. This has created a liquidity freeze.
“Asset-backed commercial paper is rolling off every day and the banks are taking more and more onto their balance sheets, which is using up capital,” said Paul Mortimer-Lee, global head of market economics at BNP Paribas in London. “It is both a liquidity and a capital crisis.”
His view was supported by a top banker who said: “Even the very solid banks that were not at the sharp end are hoarding liquidity to ensure they can fund the rollover.”
The Bank of England, which last week announced the injection of up to £4.4 billion of extra liquidity into the money markets for each of the next three weeks, is policing the problem, bankers say, but has no plans to change its tactics, which have drawn criticism.
Its first significant response to the crisis came only a few days ago, after weeks in which the European Central Bank and Federal Reserve had injected tens of billions of euros and dollars in an effort to steady the markets. But the Bank’s supporters said the criticism was unjustified, and that it had been right to limit its action. They pointed out that, properly measured, the rise in sterling money-market rates had been similar to that for dollar rates.
The prospect of serious market indigestion from maturing commercial paper is not the only headache for the banks. Globally, they have $380 billion of loans and bonds to be laid off from leveraged buyouts and other private-equity deals at a time when the markets have shifted sharply against them.
The crisis has led to a big change in interest-rate expectations.
After the Bank’s quarterly inflation report a month ago, most economists were looking for a further hike in Bank rate to 6%. Now, according to a survey by Ideaglobal.com, the financial-research company, only 36% think the next rate move will be up, while 64% are looking for the next move to be down.
Most do not expect that to happen until next year, although economists say the situation is changing rapidly.
The Federal Reserve is widely expected to begin the process of reversing the recent rise in global interest rates when its cuts the Fed Funds rate on September 18 in response to the market crisis and weak American jobs data.
Last Wednesday, the Bank and the Financial Services Authority called a meeting with Britain’s top banks to hear how bad the liquidity freeze is.
In the short term, the credit crunch is forcing up the cost of borrowing and the Bank is concerned that this could spill over into the wider economy, making it difficult for businesses to raise long-term finance.
What has compounded the problem is that nobody yet knows who holds the commercial paper that is exposed to the US sub-prime mortgage market and has been dubbed as toxic. Britain’s big banks have varying degrees of exposure but it is not seen as a huge problem. One banker said: “We don’t know yet what we could be holding on our balance sheet in one week or three months’ time. No bank will escape some impact on its profit-and-loss acount. But will it be a mega number resulting in a material hole in its balance sheet? I doubt it.”
Commercial paper is typically soaked up by pension and insurance funds. But until they are able to work out their exposure, many of them are refusing to buy any more. It is this buying strike that has created the liquidity freeze.
Another senior banker said: “What nobody knows is whether this will spill over into the wider economy”.
The crisis is having a huge impact on the way banks conduct their business. Northern Rock, the troubled bank, is facing a battle to raise up to £3 billion in funding it needs from the debt markets in the next three months.
Northern Rock has been particularly vulnerable because it relies on the credit markets for about 70% of the funds it needs to finance its aggressive mortgage lending. Some debt analysts believe that the bank may need to raise up to £8 billion if it is to sustain its ambitious targets and take mortgages that have been written several months ago off its balance sheet.
There have also been suggestions that the funding pressures could force Northern Rock to issue a second profit warning. In June the bank said that £180m to £200m in income had been wiped out after it failed to pass on higher-than-expected borrowing costs to customers rapidly enough.
Other banks, including Anglo Irish, another big user of securitisations, also face a credit squeeze.
The refinancing of the commercial paper is expected to start tomorrow and end on September 20. In that short period the City is braced for huge market volatility.
The big high-street banks are exposed to billions of pounds of commercial paper, a lot of which is high quality. But they will still need the capital to take it back onto their balance sheets. When the markets recover, analysts say there will have to be a post mortem over the different ways that America’s Federal Reserve, the European Central Bank and the Bank of England acted during the crisis. The rating agencies are already being investigated and are expected to be severely criticised.
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