Monetary Inflation - ECB Adds More Cash Than After 9/11

Thursday, August 09, 2007

The European Central Bank (ECB) has flooded the money market with an unprecedented 94.8 billion Euros on Thursday, by far exceeding the previous record of 69.3 billion Euros which it lent to banks after 9/11. As if that were not enough of a sign that markets are under severe stress the ECB said it would provide unlimited cash as skyrocketing interbank rates signaled that banks were draining liquidity, Bloomberg reported.
The Federal Reserve also added $24 billion liquidity in order to shore up suffering credit markets. A flight into US Treasuries sent the 10-year yield 8 bips lower to 4.79%.
Read the Bloomberg story after the jump.
The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.
The overnight rates banks charge each other to lend in dollars soared to the highest in six years within hours of the biggest French bank halting withdrawals from funds linked to U.S. subprime mortgages. The London interbank offered rate rose to 5.86 percent today from 5.35 percent and in euros jumped to 4.31 percent from 4.11 percent.
The ECB said it would provide unlimited cash as the fastest increase in overnight Libor since June 2004 signaled banks are reducing the supply of money just as investors retreat because of losses from the U.S. real-estate slump. Paris-based BNP Paribas SA halted withdrawals from three investment funds today because the French bank couldn't value its holdings. Stocks in the U.S. and Europe fell, a turnaround from the past three days when investors concluded that credit market risks were abating.
"There seems to be a hole in the balance sheet of World Inc. that will have to be filled by government intervention," said Peter Lynch, chairman of private equity fund Prime Active Capital Plc in Dublin. "The ECB is treating this like an emergency; it might make traders even more afraid."
No Prices
The ECB said today it provided the largest amount ever in a single so-called "fine-tuning" operation, exceeding the 69.3 billion euros given on Sept. 12, 2001, the day after the terror attacks on New York.
The ECB's decision, just one week after the German government arranged the bailout of IKB Deutsche Industriebank, is confirmation that the subprime debacle isn't contained within the U.S.
BNP Paribas stopped investors withdrawing from funds with assets totaling 2 billion euros because it couldn't find prices to value their holdings after the selloff in credit markets. Last week, BNP Chief Executive Officer Baudouin Prot said the bank's U.S. subprime "exposure is absolutely negligible."
"They simply don't know what their assets are worth," said Timothy Ghriskey, Chief Investment Officer of Solaris Asset Management in Bedford Hills, New York, which manages $1 billion of assets. "They can't cash out their fund holders, and that's the type of crisis that's really based on panic."
Federal Reserve
The U.S. Federal Reserve added $24 billion in temporary reserves to the banking system today, the most since April. Fed spokesman David Skidmore declined to comment on the increases in overnight money-market rates.
"Banks reacted to the ECB's 'sale' offer in a similar way one would react to a sale in a department store" and "got all the money they could," said Ulrich Karrasch, a money market trader at HVB Group in Munich.
The ECB intervention added to declines in stocks, with Europe's Dow Jones Stoxx 600 Index falling 1.8 percent and the Standard & Poor's 500 Index of U.S. shares down 2.1 percent to 1,466.64. U.S. Treasury notes gained for the first time in four days as investors sought the safest assets, cutting yields on two-year notes by 16 basis points, or 0.16 percentage point, to 4.50 percent.
The euro fell 0.8 percent to $1.3684. It dropped 1.9 percent versus the yen.
"The one downside to the ECB doing something is that it may suggest there are more issues out there," said Barry Moran a euro-money market trader at the Bank of Ireland in Dublin. "People are nervous."
"Extraordinarily Serious"
Credit-default swaps on the CDX North American Investment- Grade Index rose as much as 11 basis points to 71 basis points, according to Phoenix Partners Group in New York, reflecting an increase in the perceived risk of owning corporate bonds.
Three-month dollar Libor rose to 5.5 percent from 5.38 percent.
For Bank of America Corp., the No. 2 U.S. bank by assets, today's increase in overnight borrowing costs is the biggest since the Federal Open Markets Committee raised interest rates at the end of June 2004. For UBS AG in Zurich, Europe's No. 1 bank, it's the largest jump since August 2004.
Both banks said their overnight borrowing costs rose 65 basis points to 6 percent. Royal Bank of Canada and Barclays Plc also said they would pay 6 percent.
"This is an old-fashioned credit crunch," Chris Low, the chief economist at FTN Financial in New York, said in a report today. "This is not a small thing. A credit crunch, when the short-term credit markets seize up, is extraordinarily serious, almost always the precursor of a significant recession."
Bear Stearns
The euro overnight deposit rate rose as high as 4.62 percent at 8:13 a.m. in London today before falling back to 4 percent by 1 p.m., according to data compiled by Bloomberg.
Bear Stearns triggered a decline in the credit markets in June after two of its hedge funds faltered, leaving investors with a near-total loss and forcing the New York firm to put up $1.6 billion in emergency funds to keep one of the funds from collapsing.
Default rates on home loans to people with poor credit, known as subprime mortgages, are at a 10-year high. American Home Mortgage Investment Corp. this week became the second- biggest U.S. home lender to file for bankruptcy this year, joining more than 70 mortgage companies that have had to close or seek buyers.
The credit crunch also tainted the market for corporate takeovers, as investors became increasingly wary of buying the high-yield bonds and leveraged loans that private equity firms used to finance deals.
Commercial Paper
"Somewhere out there, there are several people that are in trouble - it's hard to put your finger on it," said Andrew Busch, global foreign-exchange strategist at BMO Capital Markets in Chicago. "I cannot name names. We know BNP has issues with three funds. But you do not see a movement in overnight rates like that unless there is a huge concern about liquidity and funding."
Companies are extending the maturity of existing short-term debt. Units of American Home Mortgage Investment, Luminent Mortgage Capital Inc., facing margin calls from lenders, and Aladdin Capital Management LLC this week exercised options allowing them to delay repaying debt, Moody's Investors Service said.
The three companies borrow using short-term debt that is backed by assets, known as asset-backed commercial paper. They are probably the only companies to defer payments since extendible asset-backed commercial paper was first sold 12 years ago, according to New York-based Moody's.
The average yield on U.S. asset-backed commercial paper rose 20 basis points to a six-year high of 5.56 percent today, the steepest one-day climb since September 2005.
Anybody still doubting the process of monetary inflation?

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