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On Wednesday, Federal Reserve Chairman Ben Bernanke, in coordination with five of the world’s largest central banks, initiated a plan that will make it cheaper for European banks to borrow U.S. dollars. The central banks of the United States, Europe, Japan, Canada, United Kingdom and Switzerland agreed to cut the costs of reciprocal currency arrangements by 50 basis points, or 0.5 percent. The money will be lent to the European Central Bank (ECB), which will in turn lend it to the EU’s commercial financial institutions. Unsurprisingly, the stock market rose nearly 500 points. Equally unsurprisingly, excess cheap dollars will raise prices for American consumers. Bottom line? This is nothing more than the latest effort to kick the EU debt-bomb can further down the road.
“It’s more of a Band-Aid,” said Colin Robertson, who oversees $375 billion as Northern Trust Corp.’s managing director of fixed income in Chicago. “The market is ahead of itself in believing this is the end of what’s a pretty significant liquidity crisis and the pressure that’s been building in the banking system and the euro-zone countries.”
That pressure is a constant for a very simple reason: this does virtually nothing to address the underlying problems with euro-zone countries like Italy, Spain and Greece, whose economies are on the brink of default. It is merely an attempt to reduce the strain on lending institutions with exposure to those potential defaults, and keep what little credit is still flowing from completely freezing up.
Why now? The cavalcade of bad news from the EU last week was likely part of the impetus. The lowlight was Germany’s inability to sell all the bonds it was offering, despite being the most stable economy in the EU. Yet the central banks had all weekend to absorb that information. Assuming there are no coincidences in the world of international finances, there had to be some other piece of news that caused them to act.
The bet here is that news was the announcement by S&P that it is downgrading the credit ratings on 15 large banks, including Morgan Stanley and Bank of America. Despite the fact that the downgrade was the result of the S&P changing its internal models as opposed to changes at the banks, a downgrade leads to increased costs for doing business. Furthermore, the downgrade may force banks to increase collateral levels at a time when most of them are already struggling with liquidity, because it can trigger clauses in underlying derivative contracts. This in turn makes trading more expensive in the derivative markets that provide banks with much of their income.
In effect, the central banks are giving what the S&P is taking away. The former entities are making banking cheaper while the downgrade by S&P makes it more expensive. The S&P ostensibly bases its ratings on what is. The central banks? Perhaps the movie title “Back to the Future” is apropos–as in, despite the recently revealed $7.77 trillion made available to save the banks back in 2008, most of them remain in similarly lousy shape. And exactly like 2008, ordinary Americans will never know the truth about what’s really going on until after it happens. Long after.
And therein lies one of the principal problems of the 2008 deal and this one as well. Because transparency is non-existent, no one knows which banks are over-exposed to European debt, and/or how much that exposure is on a bank-by-bank basis. Thus everyone assumes the worst about everyone else, and credit markets freeze up. Furthermore, since no one knows which banks are in the most trouble, it becomes necessary to err on the side of leniency rather than caution, and make cheaper dollars available to all of Europe via the ECB.
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