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Interbank hysteria

Robert Peston | 16:26 UK time, Wednesday, 24 September 2008

Until money markets go wrong, the rest of us barely know they exist.

But something has gone seriously awry in the interbank market, which is where banks lend colossal sums to each other.

Bank of EnglandThe measure of what's gone wrong is the record gap of almost 1 ½ percentage points - or 145 basis points to be precise - between the interest rate for lending between banks in sterling for three months (what's called three month Libor) and the market's expectation of the average overnight interest rate for the coming three months (or the three month OIS rate).

The gap has never been as wide as that, though it has periodically been over one percentage point since the credit crunch began last August.

Before the crunch, the average gap was 0.1 percentage points (10 basis points).

What that gap shows is that banks are happy to lend for 24 hours, but not for any longer than that.

In fact, banks have more money to lend overnight than they know what to do with.

They are depositing a ton of it with the Bank of England in its standing deposit facility, which pays a paltry penal interest rate of 4%.

Think about that for a second.

Our banks are prepared to lend to the Bank of England overnight at 4%, but not to each other for three months at more than 6%.

What on earth is going on?

Well the background is that banks are rebuilding their balance sheets to cope with the economic downturn we're experiencing, and they're doing that by lending less (and raising new capital).

But the more immediate cause is a sudden flare up - post the debacles at Lehman, AIG and the rest - of fears that no financial institution is safe from collapse.

So bank chief executives and treasurers think it's wiser to hoard cash (or liquidity) than to lend it out, even if that leads to a reduction in profits (which it does).

Also, there's a significant potential funding problem for all banks in the growing risk aversion of US money market mutual funds, which are increasingly reluctant to lend their trillions of dollars for more than a few days at a time (because they were burned on Lehman and because their shareholders are withdrawing cash on a significant scale).

The rise in interbank rates for lending longer than overnight is the most palpable sign of crisis in the global banking system, a crisis engendered principally by fear.

Banks aren't fulfilling their core function, of transmitting money to where it's needed.

It's why Hank Paulson and Ben Bernanke may not be guilty of hyperbole when they claim that their $700bn banking bailout plan may be the difference between life and near death for the global financial economy.


  • Comment number 1.

    Makes discussions about 1/4 or 1/2 % cuts in base rates completely irrelevant doesn't it? With one honourable exception the MPC have failed to appreciate that since the Credit crunch we have had a substantial increase in interest rates at a time when they should be falling.

  • Comment number 2.

    At least the owl and the pussycat will survive after their time at sea.

  • Comment number 3.

    Fear is the driver for closure. Without fear the banks will not sell the toxic stuff cheap and congress will not authorise a buy. Fear is needed for resolution. The slower the movement towards closure the higher the fear will have to rise until a balance is reached.

  • Comment number 4.

    From bloomberg:

    Eighteen months ago, U.S. Treasury Secretary Henry Paulson told an audience at the Shanghai Futures Exchange that China risked trillions of dollars in lost economic potential unless it freed up its capital markets.

    ``An open, competitive, and liberalized financial market can effectively allocate scarce resources in a manner that promotes stability and prosperity far better than governmental intervention,'' Paulson said.

    I think that says it all. Paulson's rescue isn't required. Capitalism can work this out - the bad banks go bust, and the good ones pick up the market share the bust ones gave up. Normal service resumes.

    Taking money from the profitable parts of the economy to prop up the failed ones is the exact reason communism doesn't work.

    Of course Paulson made his personal fortune at Goldman Sachs. So you can understand why he feels the US taxpayers all across the land should bail out his rich pals.

  • Comment number 5.

    The banks, unchecked by Gordon Brown, spent years lending far too freely, and inventing complicated products no-one understands or can value, and now the debts aren't being repaid fast enough to keep them capitalised.

    They have brought this upon themselves, and the consequences are potentially catalcysmic.

    I hope some way can be found such that (a) things are stabilised (b) the banks and bankers pay for their failures (i.e. not a straight bailout, letting this incompetence go unpunished) and (c) this never happens again.

  • Comment number 6.

    I think this situation is a direct consequence of the Lehman Brothers debacle.

    The banks had factored taxpayer support into the equation and took the view they could carry on much as before the credit crunch hit - until Lehman Brothers imploded.

    The consequential panic which followed on from the realisation that taxpayer support is not automatic caused the shareholders of the investment banks to dump their holdings. Given that these banks funded their generous bonus schemes through the issuance of shares suggests to me that the collapse in the share prices of investment banks subsequent to the demise of Lehman was largely caused by the employees of these banks cashing in their own shares.

    This is turning short-termism into an art form.

    I have observed before that we are dealing here with a cultural as well as a financial problem.

    I would suggest that the best solution is to stop employing anyone under fifty in the City. Anyone who is not middle-aged is too immature to make a balanced judgement in matters so important.

  • Comment number 7.

    Another spot-on analysis from RP. What will it take to make the banks less afraid? Are there more skeletons waiting in the depth of the cupboard waiting to fall out? Are they acting out of knowledge or fear? The attitude of the US Treasury suggests the former, because they wouldn't have pumped so much liquidity into an unknown.

  • Comment number 8.

    The LIBOR is meaningless though. No banks are lending to each other at all, hence the rate can increase substantially with no market impact to notice

    All real lending is coming from Governments.

    hence we have a true financial crisis, which is why some kind of bail-out is needed; just with better safeguards for taxpayers than the ex-Goldman Sachs CEO would like.

  • Comment number 9.

    Countary to Helping Paulson with his $700 billion bid it makes us wonder whether the market is under real fiscal stress or under extreme paranoid.....when fact and fictions are blurred....we best do nothing and not pay up. Didn't we have yuppie flu in the 80s, did we treat it no, then it was gone!

  • Comment number 10.

    These spreads are indicative of a number of things, one of which is that survival is the banks' number one issue right now, capital-raising and conservation rank alongside this, and profitability is not a particularly meaningful issue whilst these concerns remain paramount. No-one is rating bank shares on earnings multiples at the moment, but entirely on resilience and capital adequacy.

    The difference between near- and longer-term interest rates tells me that banks may expect rates to rise, irrespective of central bank policy. Logically, a shortage of liquidity in the future is likely to push rates upwards. Policy-makers hoping/arguing for lower rates please note.

  • Comment number 11.

    Hysteria is what this has all been about from the off.

    As FDR put it "…the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance"

    Let Paulson and Bernanke get the stuff the banks are all scared of off their balance sheets, and they can all move on.

    The US taxpayer will get the assets for a fear-driven price, and in the fullness of time will make money on the deal

  • Comment number 12.

    Sounds like a lot of 'wait and see' to me.

    With some uncertainty around Paulson's bailout, banks are probably holding onto their cash until they have a better idea what the landscape will look like. I imagine once they have a clearer view of the very near future they'll be better able to judge risk and not over price it out of fear - the very opposite problem to the one that got us into this mess in the first place.

    Or is this too simplistic and I'm missing something?

  • Comment number 13.

    To a man with a hammer everything seems like a nail. When Brown handed the inflation-bashing hammer over to the MPC it still had some clout.

    Recently it has become increasingly clear that LIBOR rates are completely disconnected from the BoE's aspirations. It's like a car with a slipping clutch. It doesn't matter how hard you rev the engine, or how powerful the engine is,you cannot get traction.

    Mervyn King is right to suggest that the economy is headed for severe deflation and that footling around with a quarter point here or there in the Base Rate is like changing gear up or down when the clutch is burnt out.

  • Comment number 14.

    Surely this is the time for the UK government to start issuing currency instead of the private banks and bring fractional reserve banking under control.

    If the BoE was as hard nosed as Buffet it could decline to bail out private banks, bring them to their knees, buy the assets for next to nothing and set up shop itself.

    I am a lifelong Thatcherite and former Inter Dealer Broker but I feel that the pendulum has swung. We need sound money.

    Am I bonkers?

  • Comment number 15.

    the housing problem is about 14 trillion. The Credit default swaps [cds] is about 60 Trillion. The total in all derivatives is about 480 Trillion. [10 times world gdp].

    So even with a one trillion lifeboat or 20 such lifeboats not everyone is going to get in?

    This was known back in march.

    the key is stopping the cds from kicking in through non financials running out of cash e.g GM, Ford, Boeing etc.

    So the BET is by taking on the smaller bad debt [housing] that will free up the credit market so the non financials will not run out of money and so kick in the credit default swaps [and mass unemployment etc]. And its just a bet that it will work.

    Even if it works we can expect a contraction of at least 50% [the amount of the economy fuelled by leverage and short term money markets]

    This is the greatest financial disaster in western civilisation.

  • Comment number 16.

    can someone, without hyperbole, explain exactly what would happen if we dont bail out the banks, would the world as we know it really end?
    Paulson apparently made $500,000,000 (yes five hundred million) when he left GS, how about he and his banking friends pay some of this back? if the bailout is necessary then the companies concerned should be purged of all directors who had a hand it this debacle!

  • Comment number 17.

    The package needs to pass. It won't fix the underlying problems. at best it will start recovery in credit markets. It's a good deal for those with toxic debt, although that's contingent on the valuation. I think the GS/Buffett situation is an indication that he's betting on valuations and TARP.

    I don't trust anything that the Fed and US treasury say, based on their track record, I have zero confidence in them. From their laughable 'strong dollar' policy to their statements in the last eight months. I still think this needs to pass because there is no choice other than uncontrolled panic.

    People keep saying that the US government can make money on TARP. I think they should be judged solely on their track record.

  • Comment number 18.

    If you are certain of 4% why would you take the risk of an uncertain bet for 6%? The banks were lining up last week to pick over the bones of Lehmans and buy a bargain, and yet they want the tax payer to help them out with their liquidity problems and the unknown packages. They have had 18mths to fiind out what is in their bundles they bought; so if they can't sort out what they have, then why should anyone buy the product? I am glad that bankers in the USA are being investigated, how can they not have known that something was not right? They took their bonus and did not worry about the consequences. I am not sure that they should be bailed out. Maybe we should sit it out and let it unravel?

  • Comment number 19.

    Good posts everyone and so succinct Pesto.


    You hit the nail on the head.
    The Bank has been incompetent in my view.

    As credit conditions deteriorate fast they have to lower the base rate so that lending rates etc don't go to levels that cause an unnecessarily deep recession. They have foolishly paid too much heed to headline inflation this year and not enough the lending conditions. Wages can't rise when demand is so weak and getting weaker.

    It is amazing that they lowered rates in 05 when credit conditions were relaxing fast (100% plus mortgages coming in) thinking stupidly that the lower inflation was permanent rather than a function of increased imports from China.

    Now they make the same mistake in reverse

    It is worrying.

    Graham Cox

  • Comment number 20.

    Comments are going missing.

  • Comment number 21.

    Banks are looking at each other, wondering who is going to fail next. Its no wonder they don't want to lend each other money.

    Once again, its not a liquidity crisis, it's an insolvency crisis.

  • Comment number 22.

  • Comment number 23.

    From bloomberg:

    I think that says it all. Paulson's rescue isn't required. Capitalism can work this out - the bad banks go bust, and the good ones pick up the market share the bust ones gave up. Normal service resumes.

    But isn't that the entire point. Capitalism hasn't sorted this out because 'capitalism' let it happen in the first place and then had no rescue package other than running to governments.

    I think it is fair to say that if AIG had gone bust the world economy would have died over night. It would have taken years for capitalism to sort that one out...if ever.

  • Comment number 24.


    You highlight a key issue here. The banks - by which in this context I mean the bankers - have caused this crisis through irresponsible lending (though the customers who took up that lending are not blameless).

    Paulson (and others) are now saying: "you (the taxpayer) need to bail out the bankers or else the economy will implode and you will all suffer".

    Congressmen are saying: "we may need to bail out banks, but we are not happy about using the tax dollars of ordinary Americans to bail out bankers who have earned zillions whilst screwing up the system".

    Best solution might be to inject taxpayer dollars but on terms sufficiently harsh to satisfy taxpayers, including taking dodgy loans at low prices (through reverse auctions), also demanding bank equity in return, and beefing up regulation.

    The proposal currently before Congress is unrealistic - a bail-out of banks (fine) but also of bankers (not fine), without strings or even adequate oversight.

    The answer, it seems to me, is to bail out the banks, but NOT the bankers. Send in the tax dollars if needs be. But also - and see today's headlines - send in the FBI....

  • Comment number 25.

    It is really wonderful to see that the individual citizens in the USA will be saddled with around $2500 worth of debt each if this bill is passed and the Treasury buys up the toxic debts.

    No wonder Warren Buffet is investing $5 billion in Goldman Sachs. Not only has he got a fantastic deal on the shares, he knows that once the toxic debt is removed, it is business as usual and lots more money to be made in a short term grab before the chickens come home to roost.

    Why are the crooked bankers getting a bail out? What god given right do they have not to be bankrupted personally for their criminal get rich schemes that have brought the financial systems to its collective knees.

    My own view is to be strong and let the system fail, and then build a new working system from the ground up, perhaps after having removed the leech of the Federal Reserve and the Fractional Reserve banking system. Lets face it, it doesn't work in the long term, it only makes the rich richer, and the poor end up bailing them out and carrying the burden of debt.

  • Comment number 26.

    Dear Robert

    Knowing the trend is markets shares i predict a major share fall within days.

  • Comment number 27.

    #19 Northdown


    "It is amazing that they lowered rates in 05 when credit conditions were relaxing fast (100% plus mortgages coming in) thinking stupidly that the lower inflation was permanent rather than a function of increased imports from China"

    I know that many people wrote the the Governor of the Bank of England making just the point you make in from early this century onwards.

    The reply (I have a couple of the Bank's replies myself) was always that the Bank's ONLY duty was to manage inflation against the CPI, and nothing else.

    The liquidity problem is not really about interest rates although they reflect uncertainty. The problem is trust. Lowering interest rates now would just reduces the cost of mistrust. It would not increase trust.

    To increase trust bankers must trust each others accounts - a slow process.

    I personally think that keeping interest rates high will encourage liquidity to flow from savers into institutions and this is essential for the institutions and thus lowering base rate will have little effect of interest rates. Also to avoid 'moral hazard' interest rates need, in my opinion to be higher, not lower.

  • Comment number 28.

    The world's financial system is nothing more than a system of control whereby those in power force debt upon those not in power.
    Most people still do not know that all money is debt and that banks (private and central) essentially control everything, including governments.

    Do you actually know where money comes from? Do you really?

    Banking is the world's greatest scam and the curse of humanity.
    The Great Depression of the 1930's was a redistribution of wealth and power. The current position, with 'solutions' provided by Central and Private banks is no different and the outcome will be pretty much the same. Already the Federal Reserve (a private company, by the way) now owns half of the mortgages in the US and therefore half the properties by implication. That's one hell of a deal.
    Our whole concept of what money is and what it should be needs to be addressed.
    Do you actually know? If you really did, why would you be defending a system that hurts you?

  • Comment number 29.

    I do not entirely agree with this post.

    1) I do not agree that there is an economic downturn as such in the UK yet. Although there will be and of course the debt and housing bubble is finally deflating.

    2) I don't agree that there is not enough money available in this world where it is needed. Producing industry has no problems whatsoever in financing its business. Where the money isn't available anymore is where there is already more than enough debt. That is healthy!

  • Comment number 30.

    Why don't the Bank of England reduce interest paid to 2% or less, so making it more attractive for the banks to lend to each other. The Bank of England have got to do more to encourage this process and it sounds as though they have got the levers to help in this respect.

  • Comment number 31.

    Is your logic quite correct, RP?

    Are the banks perhaps unwilling to deposit money with ANYBODY - even with the Bank of England - for 3 months?

    Could it not be that in these remarkable times the banks are behaving rather like Ken Dodd? Keeping their cash beside them in a suitcase.

    That way they have the greatest flexibility to deal with whatever happens next.

    I don't think it necessarily follows that banks have worries that other banks have solvency problems which involve a risk of not getting the money back at the end of the 3 months. It's just that they might want to do something else with the money before the 3 months are up.

  • Comment number 32.

    To comment #1 - the interest rates set by the MPC are designed to target inflation as measured by CPI. As inflation is returning, they must therefore increase to reduce demand through the transmission mechanism.

    LIBOR on the other hand, is not set by the MPC but is a reflection of the risks perceived by each bank when lending to another - with the MPC's interest rate just one factor of many that they consider.

    The recent heights of LIBOR are due to bad debt concerns and toxicity in the market, not the MPC's decisions. Dropping the interest rate would not guarantee any fall in LIBOR.

    Now faced with the twin challenges of falling productivity and inflation, I'm glad the MPC is finally waking up to the need to return interest rates to a sensible level after years asleep at the wheel.

  • Comment number 33.

    Think about it. The risk premium demanded by banks for lending to each other is only 2% points above the risk free rate. That doesn't mean that anyone believes that any bank is in imminent danger of collapsing. It just reflects the fact that, unlike before, there is *some* risk, but it is tiny.

  • Comment number 34.

    #14 drew_lg - no, you're not bonkers, in fact you're the only one making any sense.

    If the banks are not bailed out, the world will not end, it didn't end in the 1930's during the Great Depression, and it won't end now.

    Let the bad banks fail and the good ones (or the central banks) pick up the pieces.

    It's that simple.

  • Comment number 35.

    I would go much further than

    markphillimore when he wrote "Why don't the Bank of England reduce interest paid to 2% or less, so making it more attractive for the banks to lend to each other. The Bank of England have got to do more to encourage this process and it sounds as though they have got the levers to help in this respect".

    Why doesn't the Bank of England reduce the overnight rate they pay from 4% to 0.1%, or even to a negative rate if that doesn't do the trick?

  • Comment number 36.

    #34 thebigdog1

    Oh that it was that simple!
    It would be nice, real nice but:

    The UK economy relies on The City.
    The UK government needs the trickle down from the fat cats to help fund the rest of the country.
    Could what's left of UK PLC manufacturing support us?

    The government needs The City to keep the rest of us from the streets and also of course to keep the government in office.

  • Comment number 37.

    I posted this on another blog, but thought that
    you Brits might enjoy it.

    The public is invited to participate in the bailout, here.
    My favorite one is this one.

  • Comment number 38.

    Its not about the world ending if there is no Paulson deal, its about damage limitation, which is the best outcome.

    If the deal stalls and things go sour the problem then is congress will fill its collective pants and go running to the banks and pay more for the toxic stuff.

    Congress was always going to start by saying - don't like being seen as picking up fat bankers tab.

    Question is how fearful are they. There are some tough nuts there and they will play it to the max. It was never going to be easy, more sweat needed.

    If the deal stalls and the US economy nosedives and peoples house become worthless do you think that people are going to not call their senators and say get on with it I want my house to be worth something, and I want a job, thank you.

    Normally greed and fear are balanced in a deal. In this case there is just fear and fear. The banks are not going anywhere because they can't sell the toxic stuff elsewhere so it was always down to the buyer, congress. Congress would prefer to be seen as a saviour rather than paying for somebody elses party. Situation needs to develop, in the right direction preferably.

    Equally the banks are not going to let the toxic stuff go too cheap if they can help it, it does have value if the housing market picks up. You are looking at hard core gamblers on both sides. It is too early yet.

    Its no good going on about bonuses in the past. The deal is now and has boundaries.

  • Comment number 39.

    Can someone please tell me why no one is yet talking of the crisis that is about to to come to a head with the banks in Asia? The next problem for the U.S and UK economy. Have fun everyone!!!

  • Comment number 40.

    Isn't the solution staring us in the face, though many would consider it a severe loss of face?

    We need to join the Euro.

    We would get far lower interest rates, and lower costs for exporters.

    We would get a strong currency, as the one thing above all which is holding the BOE back is the fear of a run on the pound.

    We would perhaps lose some of London's pre-eminence as a financial centre- but that's shot to pieces anyway, for a good while yet.

    I hate to say it, but it must be the Euro for us.

  • Comment number 41.

    Does this mean that the BoE is effectively sucking cash out of the commercial banks, paying 4% interest, and lending it out for longer terms at much higher rates (5%+) via the various liquidity schemes?

    If so, it must be making large sums of money for the taxpayer at the expense of the commercial banks.


  • Comment number 42.

    No. 34
    ...Let the bad banks fail and the good ones (or the central banks) pick up the pieces.

    It's that simple...

    Let's just work this one through a little shall we.

    Who do you think are the 'good banks' and who are the 'bad banks'?

    Even supposing that it was possible to identify them have you considered that even the 'good banks' will have some exposure on their balance sheets to the 'bad banks' debts.

    What do you think will happen to the 'good banks' if one or more of the 'bad banks' goes bankrupt? Do you imagine that they will survive unscathed?

    Who do think Ford, GM, Boeing and other US multi-nationals bank with? Just the 'good banks', or possibly the 'bad banks too?

    What do you imagine will be the impact on those companies and others, and private individuals too, if the bank they do business with goes bankrupt? Do you imagine that the companies will be able to meet their wage bills or pay their suppliers without a bank?

    If you're a supplier and you've not been paid by Ford, how long will you be able to stay in business? If you're a Ford employee who hasn't been paid, how will you pay for food, or your mortgage?

    It's that simple is it? Get real.

  • Comment number 43.

    I don't know what you are all worrying about. The banks are just being prudent, the experience thay have gained over the last couple of years means that they will know exactly what to do to prevent things getting worse.

  • Comment number 44.

    I think the FBI should chase bigger fish...namely those who are about to pull of the largest and most blatant blackmail plot in history.

  • Comment number 45.

    No. 40

    How quickly do you envisage that it would take for the UK to ditch Sterling and join the Euro.

    Here's a clue.

    During the early part of this decade when the Treasury was working through the tests that had to be satisfied before a decision to recommend joining the Euro was put before parliament, the UK banking industry was required to start planning for the eventuality. The timeline, from start to finish, was measured in years.

    Let's just take a simple example. How quickly do you think that the UK's ATMs can be converted to dispense Euro notes? The UK's current notes are a different size to Euro notes you know.

    Or were you envisaging that we'd keep our current notes and use them at a Euro equivalent value? So a £5 note would be worth xxEuro and yycent...remember it won't be a round number of Euros 'cos of the currency conversion rate? Do you see a few problems with that? How do you think the population at large would cope?

    The current financial crisis is likely to be over, one way or another, a long time before the UK would be geared up to join the Euro.

  • Comment number 46.

    Hmm .... I don't see how joining the Euro is the magic pill for the UK. Surely it's about economic fundamentals. In the UK we relied on house prices to grow the economy while the banking sector thrived on the creation of money from criminal slight of hand. Now it's all disappearing like so much smoke.

    I suspect we will join the Euro in due course (hint: when 1 Euro = 1 Sterling) Then we will have to wrestle with the disparity in our economy versus the real economies in Europe.

    Of course I stand to be corrected, I'm sure there must be more to the UK than banks and their monopoly money and houses . isn't there?

  • Comment number 47.

    I wrote something about you on my blog:

    Keep up the good work.

    Best regards,

  • Comment number 48.

    Surely, if the US government pays $700bn for debts that are not worth that much, they will just be compounding all the other mistakes that have been made. I don't see how the US government can go beyond a current best valuation. If that is not enough to save some banks, they probably cannot be saved.

  • Comment number 49.

  • Comment number 50.

    As far as I can recall, the duties of a Director includes

    'The Duty to exercise reasonable care, skill and diligence'.

    What has become apparent is that the Bankers did not carry out this duty in relation to Toxic Loans, so yes they are in the mire due to their lack of diligence.

    And neither did the Regulators exercise their duties of overseeing that Companies acted sensibly

    And yet the Fed and Brown want us to commit our money (tax revenue) to saving these Directors and Companies who act without reasonable care, skill and diligence ???

    It would be preferable for them to be made bankrupt and locked up, and let their uncontrolled corporations go to the wall and then we can make a fresh start built around integrity.

    Lets have a boring Bank that looks after depositors cash on a no-risk basis.

    And let those who wish to exercise a no-diligence policy, continue in their role of taking risks, by using their own money.

    And then can then directly pay the associated price of failure, with their money, not with our individual savings or with the taxpayer revenues.

  • Comment number 51.

    What is with everyone wanting lower interest rates? The BoE has a mandate to set rates based on CPI. This has shot up, therefore rates should follow.

    100% mortgages etc are done for ever, so people need to be encouraged to save. We are going to have a hard recession whether interest rates are 0.75% or 7.5%, so lets keep them up and inflation down. Then maybe when the economy starts to recover people will have money to spend and deposits for houses.

    And #36, Their is more to the UK than 'The City'. Lets not forget that it was them who got us into this mess in the first place. The UK needs to move away from finance and property speculation (as we are clearly not very good at either) and back into something productive and useful such as manufacturing.

  • Comment number 52.

    "Until money markets go wrong, the rest of us barely know they exist"

    Now I wonder why that is? Could it be that our spineless media won't talk about it?

    Robert, when was the last time you mentioned debt-based, Fiat, Fractional Reserve monetary system in public?

    Have you considered my proposal yet? You know, the one I made to you on Monday? The one you have so far ignored. i.e. Develop a spine, talk about where money comes from and you might go down in history as the man who started the ball rolling in getting rid of this fraudulent system.

    Can't be that dificult. We could even help you with the long words if you get stuck.

    Do you actually intend to ever respond to any of your blogs?

  • Comment number 53.

    To all those smarty smarty pants people...

    If the Paulson bailout doesn't happen = the markets crash.

    If the Paulson bailout does happen = the dollar will eventually collapse.

    Take your pick.

  • Comment number 54.

    Re 39, what about Asia

    The problem started in the US and the repair has to also start in the US. The US will not put a cent towards sorting out a problem elsewhere. Far from going to the US being a Brown initative my guess is he has been summoned to be told what they want him to do in return for UK banking in the US being granted access to part of the deal. They can put anything in the bill or leave it out, its their bill. It has the right feel to it. I can't buy the tail wagging the dog.

    If the US contains the problem there then problems ease elsewhere, here, but there has to be repairwork here which will cost, the public always pays, thats the rule. But until it becomes clear what is being consolidated in the US then the backroom boys will keep playing what-if games. There will be pressure to let things go near to the point of collapse to see what vulnerbilities are exposed before moving.

    It doesnt matter how much gold is in Fort Knox, its got nothing to do with that, it is a promise to stand the liability that unlocks the problem.

    The US (and the UK for that matter) will not be interested in sorting Asia, Asia has to sort itself. The game looks simple, the problem is the numbers are huge. Nobody throws that sort of money around lightly. A dollar will only be put down if it saves more dollars directly downstream, and it is believed there is no choice, and there are major political issues, mainly due to the pretence that markets are free, when if fact they are all controlled, or should be, even only with a light touch.

    I suggest just enjoy the action, it won't come around again in a hurry. Why do you keep worrying about something you cannot control. You can repay Mr Brown at the polls, thats what is worrying him. You need a bandito to sort it and Paulson is one.

  • Comment number 55.

    2% is nothing. have a look at what happened to turkey during its banking crisis in 2000:

  • Comment number 56.

    Why should we continue to listen to the dumber and dumbest duo of Ben B. and Hank P? It's hard to imagine that Bernanke and Paulson who are in charge of money creation and the US budget respectively, are so bereft of intelligence (both the cerebral and the informational type) that they did not see this financial tsunami coming.

    US Fed Chairman is an academic but a failure in administration. His calls should now be questioned and scrutinised thoroughly. The worst academic is the one who demonstrates both intellectual jealousy and arrogance. It is so obvious without benefit of hindsight that debt securitisation and creation of "special financing vehicles" is a loop-hole to avoid mandatory gearing ratios. Apparently this dumb Chairman prefer less supervisory work( AIG and the US investment banks are outside his purview) to the serious business of control of money supply.

    US Treasury Secretary, who benefitted in the go-go days of invesment banking where minimal authority scrutiny is best for his personal pay check, was obviously oblivous to coming financial crisis. In his mind, everthing is all right,nothing could go wrong and he has his fat bank account to prove that the system is infallible.

    Now that we are in crisis, can we trust these two to make it right? Their work ethic are questionable, as their current solution is simply the passing of risk to taxpaying citizenry. Their cerebral intelligences were lacking in the near past, this is an indictment to failure of their bailout in the near future.

    What these two are doing is destroying USA citizens' patriotism and sense of fairplay. Their appeasement to the greedy banks and allied financial institutions is a testament to the decline of USA.

  • Comment number 57.

    From what I understand the USA alone will have to cover about $4 Trillion not the lower “affordable” $700 billion figure currently widely reported.

    There are 90,000 people in the world able to buy super yachts , in which today's Financial Times mention’s the addition of Property developers, hedge fund managers and investment bankers have stoked demand for super yachts to unprecedented levels.

    One could only assume that these people, have become SO WEALTHY on creative accounting and equally creative profits. The debt from which are now coming due, and which the rest of the population of the western world will pay for.

    Is it not more appropriate in these circumstances to create a commission, to look into false accounting and inappropriate bonuses some of which were in the $100M’s. With a military arm, to ensure that any such money is returned to the companies.

  • Comment number 58.

    The American public is the "last chance saloon" for the US financial industry.
    The British public is the "last chance saloon" for the UK financial industry.
    As taxpayers, we WILL be handed most of the bad debts of our banks.
    There is no alternative.
    It is the right solution, and the only solution.
    Is it fair? No.
    But unless we want to live in a country that resembles London in the 1800s, we will have to put up with it.
    Holding anyone to account for this will have to come later.

  • Comment number 59.

    jolo13 @ 16

    it is very hard to predict what exactly would happen if the paulson plan is rejected entirely, however this is what everyone is afraid of:

    within a month:

    banks become even more desperate to hoard cash, meaning that:
    - banks stop lending to each other entirely
    - some banks stop lending to anyone and all banks seriously cut back general lending

    banks' stock values fall to almost zero, as do most other financial institutions, precipitating a major stock market collapse (we are talking 20%+ falls here) as investors foresee all of the following

    the most leveraged borrowers (i am talking any kind of borrowers, including major companies and average joes) are unable to roll over existing debts and face their own liquidity crisis (nb the fed will pump trillions in short term loans into the banking system, but it won't be enough)

    some major banks and companies will be pushed into insolvency - their total inability to meet their day-to-day spending requirements, and file for chapter 11

    bankruptices will lead to further panic about consequential losses elsewhere in the financial system, particularly as widespread bankruptcies trigger cds contracts

    general public's loss of confidence in the banking sector and the generalised liquidity crisis, leads to widespread runs on banks (although government will do everything it can to reassure its guarantee of deposits)

    total meltdown of the financial system as nearly all banks file chapter 11 due to cascading bankruptcies

    total capitulation of the dollar (we are talking 2.50+ / eur)

    within 6 months:

    widespread unemployment due to the number of firms in bankruptcy trying to cut costs; those in employment may find their firms unable to pay out salaries

    collapse in spending due to the freezing of bank accounts / insolvency of the entire banking sector

    collapse in the housing market (characterised by complete absence of transactions as almost noone has the capacity to buy)

    massive defaults on mortgages even by sensible creditworthy borrowers

    financial / banking crises triggered throughout the rest of the world, particularly the uk, all emerging markets and east asia

    sharp worldwide recession

    obama gets elected

  • Comment number 60.

    Hey, I'm a beginner at this, Robert, but my simple analysis is as follows......

    Over the last 25 - 30 years the western capital markets have consistently rewarded those who have borrowed the most money.

    Initially it was because their governments did not understand how to, or were not politically prepared to, take the required actions to control inflation, so that borrowings were progressively inflated down in real terms.

    Then once governments had grasped the roots of this problem (...made central banks independent etc) and started properly to guarantee the value of their currencies, it was because of the asset price bubble that followed a consistent misjudging of the appropriate interest rates by those in charge (albeit because the target was prices of goods, not prices of assets, with the former having been hugely distorted by the BRICs entering the world trading system).

    One would imagine that at some stage the pendulum will swing the other way and that a proper functioning of the free market system will start to reward those who have lent the most money.

    Which will presumably mean two things....

    Asset price deflation, and an increased cost of risk free debt.

    Surely a huge US bail out of US banks just must have a serious impact on US Govt cost of debt?

    And somehow this must result in a huge transfer of wealth from the US to anyone who has lent it money, meaning China et al.

    Is this how the American empire ended?

  • Comment number 61.

    Is the fundamental issue that the real economy got decoupled from the flow of money. Essentially the US and UK to a certain extent have been buying from China on tick and now with oil where it is the West is spending huge amounts on oil that can never really be paid for unless we sell all our assets to the Sovereign funds- but when we have nothing to sell, the problem returns.
    The current crisis will I think be manged by the central banks and particularly the FED's intervention but then the West must balance books- we have to find something China and the oil producers want in exchange for their goods and oil otherwise all this cash sloshing around the world will always have the potebtial to destabilise. We have go to learn to make things again and live within our means- and that means a massive adjustment to our standards of living including public services. The problem is that we will have to be forced into this so we will wait for the banking system or the dollar to collapse before we are forced to accept reality.

  • Comment number 62.

    #50 "Lets have a boring Bank that looks after depositors cash on a no-risk basis. "

    No-risk means no lending to any business that might fail - which means most businesses and all new businesses. This would mean, for example, that many farms - and nearly all small farms - would have to go out of business, since they rely on loans to buy seed corn etc.

    This was one of the tragedies of the Depression of the 30s, that even potentially productive farms were lost because the banks could not, or would not, lend them the money they needed to survive.

    I would very much like to see RP explain in one of these posts just what the Armageddon scenario looks like, and what the results might really be. We tend to talk in very general terms about "the collapse of the financial system", but most people still seem to think that such a collapse would mean that mortgages would be rather harder to find. Perhaps a more detailed description of what the loss of the services of the banking sector would mean might be in order.

    And, as a final provocative comment, suppose we lived in a society which banned usury (lending money at interest) would this whole problem have been avoided altogether?

  • Comment number 63.

    Just looking ahead a bit, what comes after a trillion? Is it a quadrillion, or is that a kind of dance? Sounds frightening whatever.

    I think the answer to the crisis is clear - we need to restore the British Billion, which is (or was) a million million, rather than the paltry US thousand million, which I think used to be called a milliard (or at least that's what it says on my old stamps from 1933 Germany - happy days).

    Amounting to just a few British Billion, the toxic debt doesn't sound that bad really. No need to panic. Just make the stamps big enough for all those zeros....

  • Comment number 64.

    #51 chodges84

    "What is with everyone wanting lower interest rates"

    People who have borrowings want lower interest rates so that the can afford their borrowings - it is surely as simple as that?

    Not everyone wants lower interest rates - I tend to agree with you that interest rates should be higher now (and should have been higher for many years.)

    However, and it is a big however - the World banking system is going to collapse, no matter what happens to the Poulson plan. Somehow the wheels of commerce need lubricating and trust between banks must be restored.

    Lower interest rates are the 'evil' cause of the problems that we are now experiencing, but retail banking must be restored to an orderly condition. It will takes years and no quick fix will work, even negative interest rates will not work.

    #56 sizzlestick

    Agreed, but what are the steps that should be taken to limit the damage?

    Nationalise all retail banking and force the banks to lend and borrow? (The Poulson scheme is nationalisation in all but name after all.) And perhaps dismiss all senior executives and make then return their last decade's bonuses! Or do you subscribe to the Chinese solution - the firing squad! The USA does have the death penalty in many states, but I don't think it is a punishment available in Fraud Cases (I wonder why!)

    The FBI are now apparently belatedly investigating Fannie, Freddie, Lehman and AIG for possible Fraud - one of those nice long prison sentences that the USA gives out perhaps and a massive fine.

  • Comment number 65.

    Fractional Reserve Banking (our banking system) is basically a giant Ponzi scheme, you know where the people at the top of the pyramid get all the money, and the people at the bottom of the pyramid lose theirs.

    Well, the fact that our money is created when loans are taken out and that debt interest is exponential means that the lending also has to increase exponentially in order to pay the debts. Eventually you run out of people to lend to, hence US banks lending vast amounts to "burger flippers".

    Why won't the banks lend to each other? Um, because then they wouldn't be at the top of the pyramid when the borrower declares bankruptcy and they'll lose their money. It's a game of "pass the toxic debt". Like an adult version of musical chairs, someone is going to be left holding it when the music stops.

    Here's the thing. Banks don't have money...

    No... Really. They don't...

    They have debts (they owe their depositors), and they have loan agreements. All but about 2-3% of the money is given out to their borrowers (hence Fractional Reserve). That 2-3% reserve is all they have. If any more than that is called in by their creditors (their depositors... that means you) they will simply be unable to raise the cash within a reasonable period.

    They rely on the fact that less than 2% of their depositors take their money out at any one time. This is why a run on a bank is such a huge problem, it is why "confidence" is so vitally important to banks, they are all literally teetering on 2-3% reserves. If that confidence is lost and more than 2-3% of depositors demand their cash back, that's the end of the bank.

    This is true of all Fractional Reserve banks, they are all by nature, fundamentally insolvent. They all know this... Hence the reluctance to lend. And if they won't lend to each other... Should you?

  • Comment number 66.

    Big picture hypothesis

    If the US wants to buy its way out of trouble, what is it prepared to sell?

    The current proposition is that 700bn (and that may turn out to be a mere band-aid) will sit on the shoulders of the US taxpayer. So, rightly there is cause for unrest. Will the US defense budget be trimmed by the same amount? Health? Welfare? Education?

    As an alternative, what could the US sell? (and you would possibly have to balance what could be realised quickly versus what would take time). If the US was a company, how would you asset-strip it?

    Property: Alaska?
    Technology: NASA?
    Medicine: Aids drug manufacture?
    Intellectual Property: Google?

    The above is really, really "out there" thinking and, call me mad for suggesting it, what is required in the current situation.

    If (and it is a big if) I as an American citizen, Sovereign wealth fund or Country holding US Dollars are looking into a ever deepening hole, what tangible asset is on the table?

  • Comment number 67.

    62. At 10:31pm on 24 Sep 2008, pvsutton wrote:

    #50 "Lets have a boring Bank that looks after depositors cash on a no-risk basis. "

    "And, as a final provocative comment, suppose we lived in a society which banned usury (lending money at interest) would this whole problem have been avoided altogether?"

    Actually this is not necessary. Simply require them to hold full 100% reserves. The boom/bust debt problem is caused by the creation of new money when loans are taken out.

    e.g. Bank A has $1000. They are required by law to hold 10% as reserves (the real reserve ratios are closer to 2%).

    They loan out $900 and hold $100 as reserve.

    They just created $900 of new money... How? It's the reserve. It acts as the cash for that initial $1000.

    So there's (apparently) $1000 in the bank, plus $900 loaned out to borrowers. Economic boom... Repeat the loan/deposit cycle a few times to really wind up the credit. Then the debt has to be paid and it sucks all the credit money back out of the economy. Economic crunch.

    If you get rid of the fractional 2% reserve and require 100% reserves for any loan, you also get rid of the boom and therefore subsequent crunch as everything unwinds.

  • Comment number 68.

    The rise in interbank rates for lending longer than overnight is the most palpable sign of crisis in the global banking system, a crisis engendered principally by fear.

    REALLY??? I would have thought it is a sign that the financial institutions are FINALLY beginning to price risk more realistically, something which they patently failed to do for at least the last 5 years. They still have a LOT further to go.

    The Base Rate should have been raised to 8% 6 months ago. If that had been done, we would probably be in a much better position by now. With returns (ie interest rates) so low while risks are so high (and growing!), why is it still such a surprise that those with funds aren't lending them? As noted by Robert Peston in another blog, Warren Buffett demanded a 10% yield for his $5bn investment in Goldman Sachs. Low interest rates CAUSED the current economic and financial problems and therefore almost by definition cannot be the cure. Or, another way to look at it: what is worse, not being able to borrow any money at all at 5%, or being able to borrow a reasonable amount at 10%???

    I have been banging this drum for about a year now, but all the idiots charged with the responsibility of making the important decisions for this country seem to be completely deaf. The financial IQ of this country must be in single digits...

  • Comment number 69.

    Everyone read #15!

    I read an article on CDS and derivatives 3 years ago and have been watching in wonder at how long the bubble stayed afloat.

    These are figures that no person on any finance, news, government, business program/blog/website will mention because they are scary! I thought I saw genuine fear on RPs face on the TV this evening!

    The $700 Billion 'bail out' (in any form) will not plug the Black Hole that is enveloping the financial and economic world! It is like using a match stick to plug the Titanic!

    To think I was worried about the Hadron Collider last week.... What an idiot! This is going to be horrible!

    We need more Police!

  • Comment number 70.

    Comment 52 Norrie C- Someone on here who really knows what's going on. I second your challenge to Robert- come on Mr Peston, expose this fraudulent system for what it is.

  • Comment number 71.

    Robert Peston wrote that "In fact, banks have more money to lend overnight than they know what to do with".

    If that is the case, what is the problem with the banks not lending to each other? Robert Peston makes it sound as though the banks don't need the money!! Or is that the problem that some banks are awash with overnight money and others are short of funds and cannot borrow money overnight?

    If that is the problem, surely the answer is for the bank of England to reduce the amount they pay for overnight money from banks awash with funds to 0.1% and to lend at much higher rates to banks that need the funds? That way even the taxpayer might make a decent return on the deal, which would make a change!

  • Comment number 72.

    Nice link #49!

    I'm waiting for some of Milton Friedman's 'helicopter money'. Who will pay for the fuel to fly the heli up to Scotland?

    I'm off to get my biggest fishing net!

  • Comment number 73.


    Spot on - yet again!

    It's a pity no one's been listening to your drums!

  • Comment number 74.

    One wheel on their bank wAAAgons but they're still rollin along ......

    chased by...

    The derivatives market [the good ship all co. lolly pop]looking to cause
    irreversible libor dammage...

    chased by...

    .General shAAArk inVested CustAAArd and whats left of the federal reserve , looking for a last one knight stand ...

    Chased by .....

    the taxipayers that want their change from $7000billion note

    Chased by....

    Jerry looking for a piece the big cheesey

    Chased by Uncle Tom cobly and all

    Sort that lot out before the week end !!

  • Comment number 75.

    What panic?

  • Comment number 76.

    "I am a lifelong Thatcherite...

    Am I bonkers?" - drew_lg


  • Comment number 77.

    For as long as I can remember and I am well into my sixties, the financial markets keep on having major crises of confidence, in one form or another, at least once every decade.

    Most are short and shallow and do not have any lasting effect on the wider economy. Others, the ones that seem to happen every twenty years or so, tend to be more serious and can disrupt the wider economy for many years after, usually in the form of businesses going bust and rising levels of unemployment.

    It is widely accepted that all the major uphevals in the financial markets are caused by corrupt greedy speculators who deliberately try to corrupt or rig the market in an attempt to amass vast fortunes for themselves and the power that such riches can give them.

    As an outsider and because it is widely known that the people operating in the financial markets are not properly or at least effectively regulated then it appears that the system is allowed to operate as one gigantic poker game. Anyone with a certain ammount of money is allowed to play enter (scallywags and theives seem to be especially welcome) and the games goes on until there are too many corrupt players involved using IOU's to stay in the game. At that point the real power brokers decide enough is enough and the shakeout begins in earnest and then the carnage doesn't end until all the corrupt players and doggy banks have been removed. Unfortunately the shakeout is ruthless and brutal and takes no account of the impact on ordinary people's lives. If my assumptions are correct then the credit crunch will not come to an end until more banks are driven to the wall and the power brokers get their way.

  • Comment number 78.

    I don't understand all this Libor business and the glueing up of the system by Banks not lending to each other. Surely a Bank only wants to lend to a rival it either
    1 Does not need the liquidity itself or
    2 Not needing 1 above, can't put the money to good return elsewhere.
    One can imagine the scenario of Banks borrowing money from a rival that they had lent to a few days ago. Why facilitate a rival taking your business? Mind you they do seem to be pretty stupid.
    In any case why should all these internecine stand-offs between the Banks affect the external market? The money is still there somewhere and those that possess it should advertise the fact to potential borrowers. Is that too simple?

  • Comment number 79.

    I have an internet business using Google Adwords and over the last few months have seen a large reduction in the number of orders placed. Our customers are both business and private. We are at the sharp end of the economy and, as we can track the number of searches for keywords, have seen a sharp decline in searches.

    Our spending has been reduced and we are rapidly cutting overheads which will feed down the chain.

    My issue is that this business was financed by personal and business borrowing and I have seen a massive increase in our cost of borrowing from 2-3% above base to 10-12% above over the last six months.

    So if we are going to help the banks reduce their debt and free up the financial system then make it a condition that no lender can charge more than 5% above base. It would swiftly free up my money and the massive burden that people like I are under just to stand still. This alone would probably inject money into the economy and reduce business and personal failiure, which I am currently considering.

  • Comment number 80.

    There is one big thing about this crisis which I do not come near to understanding. What is all this about the banks lending to each other on a big scale - surely if they are all doing it all the time nobody, in effect, is lending anything to anybody because it all cancels out except at the margins. Are the margins (the differences between the amount borrowed and lent by a bank) simply enormous or is the interbank lending simply some scary way of "inventing" money. An explanation from someone would be much appreciated. I have to say that the more one learns about the current fiasco the more like fairyland it becomes - and no wonder it has all collapsed. Irresponsible is hardly a strong enough word. Complete and utter disregard of ones fellow citizens is nearer the mark.


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