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Panic at the ECB?

Robert Peston | 11:30 UK time, Monday, 13 August 2007

From Far Faraway Land, I hear that the Asian markets were up overnight, share prices in London have bounced this morning and Morgan Stanley has this morning put out a recommendation that it’s time to buy equities again.

So that’s alright then: panic over; normal service can be resumed for global financial capitalism.

Not quite.

The European Central Bank has today made its third consecutive daily injection of cash into the European banking system, bringing to almost £140bn its aggregated support for eurozone banks (though today’s injection can be seen as a slight reduction in ECB support). And lesser amounts of cash have been provided to financial institutions in the US and Japan.

Even if Morgan Stanley is right and this bull market has another couple of years to run, globalised capitalism will change a bit.

Here’s how and why.

As I wrote last Thursday, the ECB’s intervention was designed to stem contagion from a US debacle, viz imprudent lending to American housebuyers with poor credit histories, known as sub-prime lending.

European institutions are exposed to losses on these sub-prime loans in a whole variety of ways. Here are just some:

1) They might be owners of mortgage-backed securities, or bonds created out of the repackaging of these sub-prime loans for consumption by investors.

2) Or they might be owners of collateralised debt obligations, bonds created by another process of deconstructing and re-engineering the mortgage-backed securities.

3) Or they might be exposed to hedge funds suffering losses on direct or indirect exposure to sub-prime loans.

In fact, the most plausible way in which most European institutions have been hurt is through the transmission and amplification of sub-prime problems to other financial markets.

Here are a variety of ways in which that would have happened, most of them due to “leverage”, or the fact that hedge funds take out loans to finance part of their investments:

a) When a hedge fund suffers losses on sub-prime loans, for example, the collateral backing its borrowings falls in value. Under the terms of the borrowing agreement, the hedge fund would then be forced to sell assets. But if there is insufficient liquidity in markets, as there was last week, the forced sale of these assets would lead to a downward spiral in asset prices – which in turn would force the hedge fund, and possibly other hedge funds, to sell yet more assets. And so on and so on, until we’re all bust.

b) Investors caught in this vicious spiral of declining prices would not just sell the sub-prime and related products, they would sell anything that could be sold. Which is why share prices have been pummelled.

c) Finally, when liquidity dries up in this way, all sorts of “normal” relationships between different classes of assets change. And that can lead to unexpected losses for many different institutions, especially those which trade on the basis of computer models created from processing past inter-relationships between markets or securities. Just this morning Bloomberg has reported just such losses for funds managed by Goldman Sachs.

If you want to see how market-turmoil can generate losses in the strangest of places, just look at poor old Mitchells & Butlers, the FTSE100 company which owns pubs and bars. It recently announced it was sitting on a £60m post-tax loss relating to a complex financial transaction or hedge. It had taken out this hedge to facilitate a £4.5bn deal transferring its properties to a special new company that would be jointly owned with Robbie Tchenguiz, the billionaire financier.

That deal has been suspended, because the cost of raising the necessary £4bn of debt has become too expensive. Unfortunately, M&B had already taken out the hedge – probably a foolish thing to do – against inflation and rises in the price of debt.

Foolish or not, the hedge should not have cost it money if the traditional linkage between inflation expectations and government bond yields had held. Usually, when investors expect inflation to be on a rising trend, the price of long-term government bonds falls. But in the past few weeks, investors have sought the safety of government bonds, because of their fear that everything else – from sub-prime securities to equities – was vulnerable. So long-term government bond yields have actually fallen, at the same time as inflation expectations have risen.

After the mayhem of last Thursday and Friday, M&B’s notional loss on the hedge will be even greater than £60m.

The point is that if there is a loss of this sort at somewhere as unexpected as M&B, who knows where the next splurge of red ink will be found?

But let’s say, for the sake of argument, that systemic crisis has been averted. What then follows?

Well there are big implications for the eurozone, the European Central Bank and Brussels.

The big fact is that the Bank of England dispensed precisely zero pounds on propping up the City through the turmoil, compared with spectacular sums made available to banks by the ECB.

That means one of two things.

Either the problems at continental banks are significantly greater than for British based ones. Or the ECB simply did not have enough hard fact on the health of European institutions and panicked.

Whichever turns out to be the case, it suggests that risk-controls at continental banks are inadequate and regulatory oversight is lamentable.

And here’s what should really turn the ECB red with shame. Just possibly it has needlessly bailed out the global hedge-fund industry.

It has signalled to the hedge funds and the giant investment banks servicing them that they can take all the mindless risk they like – because if they suffer a dose of the sniffles, the ECB will turn up quick-as-a-shot with the medicine.

What worries me is that ECB and Brussels politicians will become so embarrassed by their neurotic intervention that they’ll learn the wrong lessons.

The correct response would be to improve information-gathering on the hedge-fund and associated banking industries.

The wrong, futile and more likely response would be to attempt to shut down the hedge-fund industry in the eurozone.

Comments   Post your comment

  • 1.
  • At 11:50 AM on 13 Aug 2007,
  • ryglobal wrote:

...or when the ECB intervention is really needed, they would not intervene for fear of being branded reckless.

BoE has a robust mechanism indeed for allowing anyone with unlimited access to liquidity as long as the markets come clean with a requirement of sorts and allow the BoE to have an early insight into the market health.

Well done BoE

  • 2.
  • At 12:00 PM on 13 Aug 2007,
  • David wrote:

One of the many irritations of the Hedge Fund Industry and other high risk banking activities is that they sell themselves as the stormtroopers of free enterprise. Pension rights and other workers based benefits are excessive and need cutting back as 'value' is squeezed out of assets bought with 'cheap' money. Yet when the markets react, as is their way, the central banks bale out the very people who whose mantra is based on the market and their intervention is called bringing back balance and increasing liquidity when saving rich people money should also be mentioned!

  • 3.
  • At 12:07 PM on 13 Aug 2007,
  • Michael Orton wrote:

Oh golly! When will people learn that computer models are simply advisers and not true experts? The computer model only knows the rules it has been told and applies them far faster than the human user - that user needs to know those rules equally well in order to know when the real world no longer fits them.

Will we ever know which of the ECB and BoE strategties was better? Perhaps not, but I for one prefer the BoE doing nothing. Those who take financial risk need to be allowed to win, but also to lose.

  • 4.
  • At 12:21 PM on 13 Aug 2007,
  • Antony S wrote:

So everything is OK again is it - panic over - onwards and upwards?

And UK House Prices up 12% year on year!

This really is la la land - let the hedgies et al off the hook whilst the greater fool (us consumers of debt) just keep on ratcheting up the ante. Whither interest rates now - don't raise to protect the stock market or raise to dampen the enthusiasm of us debt junkies?

Personally I think the madness will continue until a really big bang occurs - I'm only in my early 40's but can remember a time (early 90's) where you couldn't give away property - even in the best 'richest' locations. Has Globalisation and the genius of Derivatives really removed for ever the possibility of this kind of outcome? Having just read 'Fooled by Randomness' by Nicholas Taleb I suspect not.

  • 5.
  • At 12:43 PM on 13 Aug 2007,
  • robert marshall wrote:

If traders and by definition banks are bailed out then any and every type of business be it financial or not must have teh same guarantees as well. Which in effect means that no one entering business will ever have a problem.
Perhaps if the commercial and investment banks has less sugaring for the Central Banks and they in trun realised what it was like to be on teh wrong side of P/L they might learmn to treat their customers more fairly and stop ripping them off at every chance.
Don't blame the rating agencies this is a pure and simple case of greed taking over from reality and the losers must wear the blame themselves and not be able to pass it on to central banks of their own client bases.

  • 6.
  • At 12:44 PM on 13 Aug 2007,
  • Philip Martin wrote:

It's not too long ago when Alan Greenspan made a speech in which he alluded that the Fed would never bail out a prvate investment vehicle - and two weeks later the Fed did precisely that for good old LTCM.

It must surely be obvious to enyone with an ounce of common sense that there is far too much debt, without adequate backing, at play in the market - and it was bound to come to a grinding halt at some stage. Debt is a funny thing - it must be repaid eventually and when that point is reached the merry-go-round stops.

Peston is spot on with his observation that the ECB's willingness to open its purse could give the hedge-funds carte blanche to continue their shameless exploitation of the market.

  • 7.
  • At 12:44 PM on 13 Aug 2007,
  • RK wrote:

This is more of a question than a comment. How is all this money from the ECB dispensed? Do they just go out there and buy any asset class that's for sale and falling? Is most of this vast sum recoverable, might they even have made a profit? Is it targetted through certain institutions?

What I am getting at is who has profitted from the ECB intervention and does it leave them vulnerable in the future for any sort of attack?

  • 8.
  • At 12:47 PM on 13 Aug 2007,
  • John Smith wrote:

Precisely. The ECB are effectively rigging the market to protect hedge-fund and investment banks from losing as much money as they would otherwise do. As are the Fed it seems. How is this any different to Lamont trying to buy sterling to stay in the ERM? If there is a one-way bet the big money will take advantage. Who cares if a few investment banks lose money or go bust? Why are they any different to any other industry? Also, please explain how the ECB injection doesn't affect UK City banks most of whom operate globally anyway? Are you saying that a bank borrowing ECB funds in Frankfurt can't benefit from that liquidity in London? If the Banking "system" knows central banks will bail them out they will not change their behaviour, they will exploit it further.

  • 9.
  • At 01:01 PM on 13 Aug 2007,
  • Darrel Humphreys wrote:

The Europeans are interventionist in politics, and like-minded in the financial world. Did this move really come as a surprise?

Bailing out poor investments and excessive risk-taking, as the Fed and ECB have done here, sends a signal to the market that irresponsible behaviour will be bailed out. This is wrong. As a result, investors and institutions will not learn their lesson and recklessness and folly will continue.

The free-market system, if left alone, has an automatic system of self-correction that will flush out weak management and investors. Yes it is painful, but it's the only way for investors to learn their lesson. The central banks should stay out and allow the market to decide who's right and who's wrong.

you can't Buck the Market

  • 11.
  • At 01:25 PM on 13 Aug 2007,
  • Martin wrote:

Am I reading this correctly?

They are using public money to bail out high risk city fat cats?

This is a joke right?

Reminds me of that tired old saying:
"owe £10,000 and its your problem if you can't pay - owe £10m and it's the bank's problem - owe £10bn and it's the government's problem".

The ECB and FED are not only sending a message to the investment bankers, they are also sending a message to the public.

"If you are very rich, greedy and reckless, the establishment will bail you out, if you are poor then you're on your own!"

It is ironic that in the US (and increasingly here too) many low income borrowers who have overstretched themselves are now losing their homes, whilst the very rich people who recklessly lent them the money are being bailed out.

Down the line this may have political repercussions.

  • 14.
  • At 02:26 PM on 13 Aug 2007,
  • Ted wrote:

Martin, post 10. I don't think the central banks use public money to do this bailing out. What they do is effectively print money - I believe they are the only institutions allowed to do this. They do it by creating loans (out of thin air, they don't have the money that they are loaning on deposit anywhere) that can be taken up by financial institutions. This is why central banks are called 'lenders of last resort'.

  • 15.
  • At 02:37 PM on 13 Aug 2007,
  • Darrum wrote:

Philip Martin wrote:
"It's not too long ago when Alan Greenspan made a speech in which he alluded that the Fed would never bail out a prvate investment vehicle - and two weeks later the Fed did precisely that for good old LTCM."

I think that seeing LTCM was being so successful many Investment Banks copied and it was these rather than LTCM that were being bailed out.

Investment Banks do operate just like hedge funds and it is very questionable whether any should be bailed out by the Fed or ECB.

  • 16.
  • At 02:40 PM on 13 Aug 2007,
  • Gordon wrote:

Martin - You are (reading all this correctly). In this instance if we were EU taxpapers the ECB have indeed just frittered away large amounts of dosh which could have done into housing/schools etc. Just wish it was (a joke)! Mind you didn't Normal Lamont (who he?) do the same thing a few years back?

  • 17.
  • At 02:46 PM on 13 Aug 2007,
  • menon sankara wrote:

Dear sir
Your comments are interesting and timely.How often do
your blogs appear?
menon sankara

  • 18.
  • At 02:52 PM on 13 Aug 2007,
  • Jon in France wrote:

This article borders on witless slagging off of anything European. The ECB did not act in isolation, pretty much every central bank including the Fed, BOJ and Dear Old BOE increased their activity in the money markets to ensure liquidity. These banks enter money markets pretty much every day - only the amounts involved are unusual. The money goes as loans, not as gifts. The idea that the ECB is any more interventionist than the rest is pretty crass.

Still, I suppose that a crisis averted (possibly - personally I can't see that this sub prime business is not going to bite us all in the bum at some point) isn't really very exciting from a news standpoint.

  • 19.
  • At 03:11 PM on 13 Aug 2007,
  • John Smith wrote:

Frankly this is a disgrace. If I couldn't pay my mortgage the bank would not print more money and lend it to me at a preferential rate. But when it comes to some of the richest people on the planet - investment bankers, different story. Is this what they mean by moral hazard?

  • 20.
  • At 03:15 PM on 13 Aug 2007,
  • Peter Bench wrote:

Mr Preston, sadly you demonstrate a complete lack of understanding of financial markets in your condemnation of M & B. Firstly, if a business is involved in a financing transaction and waits until the deal is complete, every bank will know this when the company comes to hedge and hence the price of the hedge will rise substantially. As you yourself point out, it was the market movement against the debt position, not the hedge, that has forced the postponement of the trade. Hedging is not like buying (more-or-less) fixed price insurance like buildings or contents cover. Secondly, the 'loss' of £60m has to be placed in the context of the overall deal size, £4.5 Billion, and the balaance sheet size of M & B. Lastly, of course, you should always point out that a 'hedge' is always a transfer of one type of risk for another, not an absolute guarantee of a one-way financial outcome. Bit of a shame you didn't bother to ask the company to explain.

  • 21.
  • At 03:16 PM on 13 Aug 2007,
  • Dick wrote:

Governments are missing a trick here.

In return for bailing out these hedge funds et al out they could impose some new and useful rules such as no bbank can lend anyone a mortgage worth say 2.5 times their certifiable salary..

They could also insist that all funds but especially PE companies reserve X% for investment in start-ups.

  • 22.
  • At 03:21 PM on 13 Aug 2007,
  • John Smith wrote:

So how do the stock markets react knowing the central banks will bail them out? FTSE-100 rises 2.32% by lunchtime today. Who is buying/not-selling? Investment banks; hedge-funds; private equity funds. If excess liquidity and easy credit is the problem then throwing more liquidity and more credit at the problem just makes it worse. If the banking "system" needs to collapse then it should be left to collapse. Governments won't allow this to happen however because they would lose power. Gordon Brown is relying on his prudent economy (i.e. massive credit boom) to stay in power. Falling share/house prices don't fit his vision. The govt. inv. banks and hedge funds are all as corrupt as each other sadly.

  • 23.
  • At 03:22 PM on 13 Aug 2007,
  • Rich wrote:

In response to the question about where the ECB's money has come from, the answer is not public finances or tax revenues at all, as some have indicated.

Central Banks have a duty to be the lender of last resort and hence provide liquidity when the financial markets are severely distressed, for example to the point where no market exists for certain instruments.

At this time it will extend loans to the financial institutions in question to enable them to continue in business until liquidity returns to said market. The institutions that choose to partake are required to pay back the loan at whatever rate agreed over whatever term is on offer, largely down to the discretion of the central bank in question.

In the mean time thanks to fractional reserve banking (where a lender can lend more than they hold in reserve) and the act of printing money (which central banks have a licence to do), in theory the average member of the public can use the financial system as per usual. However, this could devalue the domestic currency and introduce inflationary pressures. but since this is for the short term, inflationary concerns would come second to the financial stability in such a stressed scenario, for a short time.

One request though; can people please stop with the scaremongering (with respect to "where will all our taxes go....?") and the pursuit of their own agendas using misinformation, and give factually correct answers to these questions. If it is an opinion then by all means express it but please do not mislead, that will just add to the problems of last week!

On a more personal note, I have enjoyed the debate the market instability has brought and I daresay there many hedge funds out there who are enjoying the instability too - remember part of what gives a market liquidity are the hedge funds taking long/short positions to take advantage of arbitrage opportunities. Without them our pricing would be woefully out of date on many instruments.

Although it appears to me that alot of the problems are associated not with finding a market price of these assets but in fidning their own tangible worth - perhaps a comment more for the other string on this blog related to BNP's comments last week.....

  • 24.
  • At 03:37 PM on 13 Aug 2007,
  • ACL wrote:

The instability in worldwide markets due to sub prime related losses might not yet be over.

Most analyst seem to believe the US sub prime related losses are in the region of 50 to 150 billion pounds while the total announced losses so far are a fraction of 50 billion.

So look for more companies to own up to their sub prime exposure in the coming month and watch the worldwide stock markets bobble a few more times.
Who knows, maybe the BoE would start intervening when British financial institutions start announcing their bad news.

  • 25.
  • At 03:57 PM on 13 Aug 2007,
  • A banker wrote:

None of you whingers understand the market. You were free not to take on debt. The banks were free to get whatever deal they can.

The fact that you might lose your house while a bank gets cash is none of your business. You are weak, losers.

As the saying goes under free markets "you have the ultimate freedom, the freedom to starve." Alfred Sherman.

Get used to it.

  • 26.
  • At 04:23 PM on 13 Aug 2007,
  • Tom wrote:

Can anybody tell me what the implication of all this restored (i.e. new) liquidity is for inflation. Will the Euro-zone now require increased interest rates to control the inflationary pressures from this new money, and how about the impact of Euro / Dollar / Sterling exchange rates?

  • 27.
  • At 04:26 PM on 13 Aug 2007,
  • Tim Corthaut wrote:

I agree with jon (post 18) that this entry, and even more the large majority of these comments, border on good old mindless EU bashing. Firstly the expression 'ECB and Brussels politicians' disregards the institutional autonomy of the ECB. Of course ECB decisions have major economic ánd political ramifications, but they are not the result of the interventionist politics of European politicians. Secondly, the ECB is also not simply giving away tax payers money. It is simply doing its job, lending (expecting to be paid back) money at interest, albeit slightly cheaper than usual, to ensure that sufficient money continues to be in circulation at a time the normal reaction of banks (or their computers) seems to be stop lending. Whether the amounts spent are overkill remains of course to be seen, and there is indeed something like a moral hazard if investors start to rely on the ECB intervening whenever their foolish investments backfire. Yet, at the same time, living in a small eurozone country, it is reassuring that we now have a robust institution managing monetary stability across the eurozone, capable of forcefully intervening when deemed necessary, thus better shielding us from volatility than any of the seperate national banks ever could. Or as was argued in a Belgian newspaper over the weekend: the ECB makes it possible for Belgian coalition talks to drag on for weeks without much financial pressure.

  • 28.
  • At 04:29 PM on 13 Aug 2007,
  • iamagreatskier wrote:

To "A banker" post 25 - what a load of rubbish - there is no such thing as a free market. If there were a free market then why did the Germans organise a rescue package for IKB? If there was a free market why have the ECB et al stepped in with a liquidity package? In a free market banks, hedge funds et al would be free to do what they wanted [legally] and then be allowed to go bust. This doesn't happen so how on earth can you talk about "free" to do this and that. Why should the banks get bailed out when we the little man on the street cannot. Not much of a free market!

  • 29.
  • At 04:32 PM on 13 Aug 2007,
  • John Harley wrote:

Frankly, I am confused. While this all sounds very easy the sub prime situation has been with us for months. Many of the banks have already provided for the losses, some of them having completed two quarterly reports in the meantime and an AGM. The Banks are supervised so why do we have a sudden panic when many of the Bank and Hedge Fund key Executives are sitting on the beach?If the Banking and Securities regulatory Authorities knew/suspected a problem why did they not flush the problem out earlier and provide a controlled level of credit/banking lines earlier rather than panic lending in four days?I think that there is more to this than we have seen/heard to date.

  • 30.
  • At 04:52 PM on 13 Aug 2007,
  • An observer wrote:

Junk mortgages? Junk bonds?

I still don't understand - why did you put question mark to this statement?

  • 32.
  • At 05:09 PM on 13 Aug 2007,
  • Tom wrote:

Can somebody answer a question?

If, as you say (comment 14), the banks are just creating money to increase liquidity, isn't this enormously inflationary.

Are we not just going to end up with a big hangover in a few months time as inflation rises and so interest rates have to rise again to control it?

If so, this is a self-defeating policy that will cause greater long-term harm than simply allowing the market to manage itself.

  • 33.
  • At 05:28 PM on 13 Aug 2007,
  • Jacques Cartier wrote:

Investors are the only people who become miserable when the commodity they crave falls in price. One would expect them to be overjoyed at the cheap availability of shares in quality businesses.

But even I’m subject to it. I’ve been holding cash in the hope that things would drop through the floor, yet when that happens, I’m too scared to buy in case the prices are only half way down! Woe is me – I wished I could get rid of this fear and greed.

As for the ECB, surely they haven’t just given the cash out, have they? If those billions are no longer in their vaults, then who received them and what was taken in return? How does one physically arrange the distribution of 150 billion euros, assuming one had the money in the first place? I think we need some answers.

  • 34.
  • At 05:38 PM on 13 Aug 2007,
  • Tim Young wrote:

Let’s not go over the top here. The ECB operation is kind of bailout, but a temporary one. What they have done is to lend the banks money for a day or so, on a secured basis, to prevent the development of any catastrophic panic. Such intervention is arguably one of the stabilising functions of central banks. What I do not understand, however, is why the ECB did not insist that the banks use its marginal lending facility, a standing facility which they may draw on in unlimited amounts given good collateral – at a penalty rate of 1% over the normal ECB repo rate. By lending to the banks at just over 4% since Thursday rather than 5%, the ECB has let them off paying several million euros already.

  • 35.
  • At 05:56 PM on 13 Aug 2007,
  • Steve wrote:

The general market consensus is that it's the BoE that is the problem, not the ECB or Fed. The reason that they acted is because the relationship between the policy rate that the central bank sets and the interbank rate that companies and people can actually access has completely broken down. The ECB and Fed injected liquidity in order to restore this relationship. If the BoE continues to hold off, and the market problems continue, then the policy rate that the BoE sets becomes completely meaningless, and thus their inflation targeting goes out the window.

  • 36.
  • At 06:12 PM on 13 Aug 2007,
  • Andrew Dundas wrote:

Would the ECB ever be able to manage cash needs in relation to such large and complex markets as are in London? Could the UK ever be sure that some continental bank isn't going to take some huge bet on the assumption that the ECB will bail them out.

As ever, the ECB has less reliable data on which to make it's judgements. That must be put right soon.

  • 37.
  • At 06:43 PM on 13 Aug 2007,
  • Peter wrote:

Many of the comments posted make the valid point that the funds the ECB lent into the money market must be repaid, in time, by the relevant (bank) borrowers. A key issue, however, is "will these banks/institutions - especially the ones that the other banks wouldn't lend to - be able to afford to repay the loans" (given any losses on hedge funds, CDO's, etc.) If they aren't in a position to repay, this is effectively the ECB extending sub-prime financing to the banks involved. Any credit losses on the 140 plus billion euros of ECB loans will eventually have to be made good with funds/taxes raised from EU citizens.

  • 38.
  • At 06:57 PM on 13 Aug 2007,
  • Jon in France wrote:

"Can somebody answer a question?

If, as you say (comment 14), the banks are just creating money to increase liquidity, isn't this enormously inflationary."

It's not quite that cut and dried. The ECB (like all central banks) has reserves. They can lend them to the markets. They can (in principle) even borrow cash from elswhere and lend on. The larger multinationals will lend their cahs holdings, for example, at sometimes very competitive rates. What they do not do these days is just print more money. 140 €bn may sound like a lot, but in the context of eurozone GDP it is peanuts.

  • 39.
  • At 07:11 PM on 13 Aug 2007,
  • SC wrote:

"Have the billions spent". What an headline ! The problem is it's wrong. Repos, the liquidity provided, are short term collaterised loans. Whilst we can argue about the acceptability of the collateral that would not change the fact that the money is out on loan to be repaid and thus is hardly 'spent'as youn describe it.

I know you have to sell product,but can you tell me how, when you sell it through drama rather than fact, do you differ from the 'banks/funds' you are panning for their financial skewing of the 'truth'.

The herd are running for the door and it isn't discriminate. In there are highly leaveraged funds who need a lesson in prudence and right alongside are other funds who are solvent ,but are pressed regardless to sell off investments that have little or nothing to do with the issues at hand.
The central banks understand this and by making short term funds available they are in effect putting a brake on the surge for the door and making it possible for sound investments to remain intact. These are not just the province of large investors ,they also include the hard earned money of Joe Bloggs.
So, get a moral conscience and stop with the drama. Consider this a sermon from The Last Boyscout.

  • 40.
  • At 07:54 PM on 13 Aug 2007,
  • kamal wrote:

Free markets do not exist. Everything is rigged. If free markets existed, these hedge funds would be allowed to make money as well as lose it. The current situation is that adding liquidity, i.e. printing money without its equivalent in gold... will help some of these institutions and save them from bankruptcy but it will also devalue the money you have. The rule that awlays applies is the rich get off the hook and the poor, pay the price.

  • 41.
  • At 08:13 PM on 13 Aug 2007,
  • J Bennett wrote:

If the UK housing market is considered overvalued by a financial institutions - and at the very least there is a good argument that housing market is overvalued - then surely those institutions will not lend 100%, or close to 100% of the value of the property in the current climate, as they would not easily be able to 'resell' the loan on and protect themselves.
This will affect the number of mortgages approved where a considerable deposit is not involved. This might perhaps produce a self sustaining decrease in house prices.
Already some mortgage companies seem unable to get funds that they are then able to lend.
Perhaps wait a month or two if you thinking of buying a house.

  • 42.
  • At 08:14 PM on 13 Aug 2007,
  • James wrote:

Does not the printing of free money not eventually stoke a little more inflation somewhere down the line ? Or is that just an old fashioned notion.

  • 43.
  • At 09:01 PM on 13 Aug 2007,
  • JayKay wrote:

In my view, the ECB is not doing the right thing by injecting funds into the system. Firstly, the current inflationary situation is caused due to irresponsible lending practices by banks. Take the case of UK house price.Assuming the uk house price is growing @10%p.a, Borrowers are in the money just by paying a small premium (monthly mortgage payment) to the bank. This is causing an asset bubble because one can easily make money without investing anything.While, the BoE and many other central banks are trying to fix this issue by raising interest rates, the ECB's decision to inject cash into the system is an act of market manipulation.
Secondly, there is no shortage of liquidity.I am sure there are no dearth of savers in the market who are willing to save , only if banks give them decent rates.

  • 44.
  • At 09:15 PM on 13 Aug 2007,
  • Jim Manning wrote:

So the ECB have created a few billions. But which EU country/EU institution profits? Thats x amount of billions they've just created out of thin air so who gets the siegnorage profits?

  • 45.
  • At 09:32 PM on 13 Aug 2007,
  • Pavel Bradut Boghita wrote:

The main points of this article as I've understood them:
- the americans are crooks (getting european banks to finance dodgy deals)
- the european bankers are incompetent
- BOE is ok

  • 46.
  • At 09:42 PM on 13 Aug 2007,
  • DaveH wrote:

J Bennett (41) is pointing up another issue - namely the differing policies of the central banks. While the Fed and ECB have pobably tightened as far as they need to, the BoE's consistent failure to price money properly has produced a housing boom equal to that in the US. The US version has been tottering for some time and now some real problems mean it needs to act - the BoE could now get away with leaving interest rates where they are (no more effect on consumption), while the disappearance of the cheap money used to finance the fixed rate mortgage deals will slow housing price rises. Both will help the overall level of consumption and thus economic growth to move ahead steadily.

Another problem for the ECB is that European banks have become highly reliant on the U.S. interbank market to finance their dollar funding needs, so they actually need greater liquidity than UK banks, which have far wider access to USD funds in London. Likewise, derivatives in London are cleared through LCH.Clearnet, which was robust enough to deal with Barings without dipping into its back-up funds - although in that case, the BoE increased liquidty to restore confidence. Are the European clearers as robust?

  • 47.
  • At 10:30 PM on 13 Aug 2007,
  • Mike Dixon wrote:

I believe that the ECB knows very what it is doing and why. In terms of the size of the Euro ecnomy the sums involve are tiny. I suggest that the underlying worry is that state of the sub-prime mortgage market in the US might just be the tip of a very unstable iceburg. For example what about the 10 billion loaned to the broke Ford Motor Company on the security of their unsaleable factories? It happened in the UK in the late 1980s, every local bank mamager being pressurized to sell more loads than the guy down the street so the loans got more and more doubtful until the whole banking system was under threat.

  • 48.
  • At 10:42 PM on 13 Aug 2007,
  • Andrew Miller wrote:

Your article implies that you have greater insight into the financial affairs of European banks than the banks, or the regulators themselves. How can you know that the ECB were wrong to 'inject £140 billion'.

Your comments are often illuminating, but in this case, you seem to be shooting from the hip with very little evidence, almost wishing to melodramaticise a relatively common occurrence. i.e. a dip in share prices. This does not signal Armageddon, provided the regulators act promptly to avoid an over-correction. There is nothing fundamentally changed from a month ago. Companies are continuing to produce good results and forecasts.

So cut the melodrama and report the facts. Some losses have occurred at some European banks and some funds specialising in sub-prime American mortgages have endured severe losses. End story. The rest of the world's economy (99.5%+ I guess) continues to prosper.

  • 49.
  • At 10:46 PM on 13 Aug 2007,
  • Greg wrote:

Having read a lot of threads on this issue over the last week, it seems to me that Tom - post 32 - must have it right. This injection of money will be used to someones advantage to bail out their risk (A Soros-esque figure or figures), but it seems to me that this cash injection will send the wrong signal to the markets and we will see worse problems in the end, losing taxpayers money through the favourable interest rates given by throwing good (printed cash) after bad. I agree that we need the markets to understand they will not be bailed out for mismanagement and staggering greed through developing complex CDO's (CDO's squared too)and the like designed to baffle idiotic financiers into thinking they are safely buying risk. I hope peoples pension pots ride the storm and we don't see further finaly salary scheme closures and schemes collapsing as the big boys panic.

  • 50.
  • At 11:12 PM on 13 Aug 2007,
  • shaun wrote:

And if the ECB was trying to buy time to let others get out from "locked in" positions (of one to four years)? ie Pension funds and other institutional investors are the ones that might panic, and it could cost them millions to "exit" a hedge fund prematurely.

The political backlash from major pension (EU) funds loosing billions would be more devastating than in the US.

There is one other factor that I find difficult to factor in; the Fed has allowed unbridled takeovers and financially dubious new methods of packaging debt etc under the guise of a "freemarket'. Provoking a huge rise in personal debt. The UK has followed suit. Since most profits from hedge funds are sent overseas to minimise taxes (even the German Bank was doing this), the actual cash is therefore stashed away, out of sight. It is obvious that when the housing bubble takes effect, all that cash will be "repatriated" to buy out individual assets (homes) and smaller businesses. (This process is well underway in the US. Even major multinationals are already offshored)

My question is this; who are the ECB protecting? Hedge funds, Banks, Private Equity funds, or Pensions, "National" investors such as China, Oil states, who have decided to put their money in Eurozone financial institutions?

The Central Banks of the two places that profit most from liquid "slosh" funds of rich individuals (London and US), only put in relatively small (or none) amounts of liquidity. Had the cash been transferred there already? Leaving the Eurozone outside as the patsy?.

  • 51.
  • At 12:05 AM on 14 Aug 2007,
  • Jeff Gray wrote:

£140bn aggregated support for eurozone banks over three days!!! Is it working? How long can the central banks continue this level of support? What happens when it is withdrawn? Are we facing a meltdown?

  • 52.
  • At 01:35 AM on 14 Aug 2007,
  • Gorilla Pie wrote:

Whilst is looks like the financial meltdown predicted last week has been averted in the short term, I find this all quite hard to believe. Central banks simply pumping more currency into the markets seems all too easy. What about the implications for inflation? Something has to give at some point, surely?

Whilst acknowledging the City's role in driving the UK economy, I can't help feeling the bankers have escaped by the skin of their teeth here.

Painful though it would have been, I actually feel cheated that the violent market correction many commentators predicted last week already seems to have been defused. I can't help feeling that a more serious jolt would have been useul in the longer term, in terms of highlighting fast and loose practices amongst many hedge funds and the financial insitutions that back them.

Instead, we seem to have returned remarkably quickly to the ticking timebomb of recent months. Oh well, as long as a handful of City boys can keep making ludicrous amounts of money, I guess that's far more important that long-term global financial stability, right?

One final question, to which I'd appreciate a response as my understanding of the markets is embryonic. But surely the very raison d'etre of many hedge funds is to profit from financial uncertainty? And yet, hedge funds have helped precipitate this latest scare by repackaging all those unwise sub-prime debts in the first place? Is this all therefore a gigantic stunt to generate yet more market nervousness, off which the more intelligent hedge funds can feed?

  • 53.
  • At 03:33 AM on 14 Aug 2007,
  • Andrew Stephenson wrote:

Where does the money for the bail-out come from? Well, actually, it comes from us - the public. It's my money and yours.

Those of us who have been prudent are being charged to prop up careless banks and lenders and those who have slipped imprudently into debt.

This debts will to some extent be written off as bad debts, paid for by us - you and me.

The lenders will continue to trade -and will continue earning good commissions, wearing nice suits and driving nice cars - and they will continue to make the same mistakes - knowing that ultimately you and I will correct any mistakes they make - and we won't even be consulted about it - because after all they are more important than us and they know what they are doing, right?

  • 54.
  • At 07:20 AM on 14 Aug 2007,
  • Chris S wrote:

#39 Spot on. There is a cost involved in lending money when no one else will, without getting risk premium due, but this is exactly what the central bank is supposed to do (and one of the things they failed to do which caused the Great Depression). They are not paying for the losses, they are simply aiding liquidity.

Some of the naive comments here about free markets should read about the Great Depression.

Does the printing of money cause additional growh in the money supply and therefore inflation? Not necessarily. A credit crunch is a contraction of credit, effectively a shift in preference towards holding liquid money, and puts heavy breaks on creation of credit in favour of the more liquid sort. The central bank is accommodating this (most likely temporary) shift in the preference by "printing" liquid funds. They can mop it back up when things turn back to normal.

  • 55.
  • At 09:00 AM on 14 Aug 2007,
  • Ian Kemmish wrote:

"[The ECB]... has signalled to the hedge funds and the giant investment banks servicing them that they can take all the mindless risk they like "

This, surely, is what the EU is all about (at least as far as anyone except us ornery Anglo-Saxons are concerned)? Why deny hedge funds what they gladly - and endlessly - give Airbus or French agribusinesses?

  • 56.
  • At 09:58 AM on 14 Aug 2007,
  • cs wrote:

I think post 37 has it about right.

The central banks are adding liquidity - presumably by offering loans. They have been forced to do this because the players in the market are too suspicious of each others exposure to deal.

So, if those taking the central bank's loans are indeed badly over exposed and do fail, then it presumably be the central banks who hold (and will have to write-off) the bad debt.

What we don't know is what criteria and terms are being applied to these loans.... and hence what is the risk that the central banks will end up footing the bill.

  • 57.
  • At 11:06 AM on 14 Aug 2007,
  • Simon Morrison wrote: the ECB has gone bonkers
does it make a lot of sense to get irretrievably tied into this eu/eurojoke thing as we are about to do? Is it just for the pretty number plates? I think we should be told...

  • 58.
  • At 11:15 AM on 14 Aug 2007,
  • Patrick wrote:

Why don't they rename the term 'injection of liquidity' 'pinching the pockets of those on fixed incomes for the benefit of the super-rich traders and hedge-fund managers'?

  • 59.
  • At 11:16 AM on 14 Aug 2007,
  • Patrick wrote:

37 and 56... Banks just print the money out of thin air! They print it out of thin air and then charge interest when they loan it to you. You work to pay back wealth that the lender never had in the first place. The whole monetary system is a giant scam. I am not interested in this paper system any longer. It bores me. Gold and silver are the way forward. I want to be able to own my own money.

  • 60.
  • At 12:46 PM on 14 Aug 2007,
  • chas wilson wrote:

Would anyone or could anyone offer a comment about and if true,try to understand what we are all about to confront.

  • 61.
  • At 02:31 PM on 14 Aug 2007,
  • Sam G wrote:

I worked for a short while on securitisation in Italy. This alchemical process has boomed in Europe; maybe the ECB realises that there is a massive quantity of home grown (ie European) worthless securitised paper waiting to ignite on the sparks from across the atlantic

  • 62.
  • At 03:21 PM on 14 Aug 2007,
  • D N Kristensen wrote:

I read most of the comments with great interest but may I suggest that it is not the hedge funds but the bankers that have created this mess. The ECB has been manipulated by the 'old school tie' after the hedge funds have created 'the paper' and sold it to and via bankers that are nothing but ruthlessly hungry for profits. When you get to the bottom of it the LTCM debacle was nothing more than a 'ponze' scheme and so is the sub-prime market. The next move may just be the rapid fall in the value of the Euro. We've seen the rise. What goes up must come down ...!!!

  • 63.
  • At 04:49 PM on 14 Aug 2007,
  • an wrote:

The ECB has used our tax money (we are a net contributor to europe) to bail out insurance companies who have underwritten subprime debt that has been parcelled together by money grabbing hedge funds, who know that if anything goes wrong they will be bailed out, at the same time making companies move our jobs to China and pushing up house prices. I can't just print money when i run out.....

  • 64.
  • At 05:44 PM on 14 Aug 2007,
  • Stephen Brooks wrote:

In response to "Gorilla Pie"/#52, when hedge funds "profit from risk", I think that means they actually cancel the risks of various correlated investments, meaning they can give a more regular and stable (and, often, higher) return than other sorts of fund.

This works very well when the various prices are wandering around a relatively "flat" piece of economic terrain. It does not work well near "cliffs" or situations where there will be a very sudden change. Another signal of the presence of "cliffs" is lopsided risk - individual loans are very lopsided, with a small chance of losing everything (default) and a much larger chance of making a small profit. Packaging together many loans assuming a "flat" landscape can average this effect out, but unfortunately this assumption is wrong because an overall economic downturn will effect _all_ borrowers and thus the different loans making up the package (CDO or whatever) cannot be considered independent. So there is still the "cliff" situation of having a much larger number of defaults than statistically expected. These are difficult risks to add to a hedge model because we don't fall off a cliff very often (once per decade?)

  • 65.
  • At 06:31 PM on 14 Aug 2007,
  • mat wrote:

Panic is not word, this is the biggest bank raid in history.
Watch out for tomorrow or day after, more withdraw problems. seems to me there might be a bank run.

  • 66.
  • At 10:52 PM on 14 Aug 2007,
  • johnny hubbard wrote:

to anyone who has said £140 billion is, even in euro-wide terms 'peanuts'...
if europe gdp is about 7trillion that means 140bil is around 2% of total annual euro gdp. that's a lot to spend on gambling in a couple of days by anyone's standards. so even though the pain from falling stocks, funds, whatever, would usually, ultimately, be borne by the masses one way or another, it does seem to me that bailing out by lending without proper collateral or a respectable premium to make up for it, is just repeating the same mistakes which caused this 'sub-prime' thing in the first place. except on a more momentous scale. good money after bad is it?
as someone said earlier, the only guys who really make money from it (the 2+20 guys) are sitting on a beach somewhere knowing that the bonuses from the last few years are safe no matter whether they have a job to go back to.

  • 67.
  • At 08:42 AM on 15 Aug 2007,
  • mc wrote:

A long time ago I read a small book about economics, a paperback I think. In it was a bit about debt and how to deal with it - spend less and produce/earn more. Nowhere did it say that the solution lay in injection of money into the system. Simpler times maybe? Or perhaps the belief is that the money injected will be used for profitable investment rather than more consumption and further pumping up of asset prices? Is that the lesson from the last great monetary injection of post 9/11? I cannot see any resolution to this mess that does not end in unemployment and poverty, whether through hyperinflation or deflationary depression. Interesting though that the witch hunt has started. Perhaps we should all look at our own behaviour and attitudes to debt?

  • 68.
  • At 10:39 AM on 15 Aug 2007,
  • A banker wrote:

"The lenders will continue to trade because after all they are more important than us and they know what they are doing, right?"

Basically yes, we are more important than you. You have no value, we do. Try and understand the realities of the market.

  • 69.
  • At 10:46 AM on 15 Aug 2007,
  • Rich wrote:

In response to various comments on here i think blaming hedge funds is somewhat misguided.

The people who lent the money so irresponsibly are the source of the problem. Those Inv Banks who packaged up the debt to sell on and "spread the risk" are next in line and then all of the funds who have invested in them are "victims", but not necessarily of the innocent variety. Do i feel sorry for those hedge fund manager and inv banks who have lost out though? NO. Due diligence anyone?

The people who have lost out directly are the big boys, yes. The rest of us may well lose out indirectly as the panic has spread from debt to equities but trying to apportion blame and saying that all hedge fund activity needs to be monitored is ridiculous.

The sad truth is that those who are responsible, either first in line or second, will not be sufficiently punished and why the various central banks operate a zero failure regime is beyond me. Let someone fail, and fail spectacularly. Markets will recover and be stronger for it.

  • 70.
  • At 11:18 AM on 15 Aug 2007,
  • golfer wrote:

This is not a 140 billion dollar question. This is about credibility. There is a sense that the so called big boys have somewhat misled investors , while stuffing their own pockets with hefty bonusses.

  • 71.
  • At 01:37 PM on 15 Aug 2007,
  • Richard Marriott wrote:

Ted - Post 14 - yes, the central banks are printing money. However, one of the big dangers with doing that is that it is very inflationary - so ECB interest rates will end up being higher than otherwise at some point as a consequence. As they say, you cannot buck the market, only ride it.

  • 72.
  • At 03:14 PM on 15 Aug 2007,
  • freakonomist wrote:

The ECB injected cash into the system because a person from Detroit was defaulting on Loans. Sounds strange but true. This is a classic example of the effect of globalisation. Globalisation is a very complex model. Firstly, the underlying risks are difficult to assess. There is geopolitical risk, country risk, enviromental risk and various other risks. Secondly, the rules of the game are not the same. Investment opprtunities , procedures and laws are different in different countries. Thirdly, there is always added overhead, costs , anxieties in managing projects that are spread across the world. The first casualty of globalisation was Enron. The company collapsed a few years ago, partly because the company lost its investments in a greenfield project somewhere.

  • 73.
  • At 08:52 PM on 15 Aug 2007,
  • Toni wrote:

The ECB did not just splurge all this money into the markets. It allowed the interbank market to access funds at its target rate, when the banking system was trying to charge to much to borrowers or refusing to lend to borrowers because they are unsure of the credit quality of those borrowers. The money has to be repaid and it is only short-term, (overnight and tom/next. The ECB is based on the Bundesbank and as such follows their anti-inflationary policies. The Germans, in case you didn't know, are highly aware of the risks of hyper-inflation and will do literally anything to avoid it. All the central banks are doing is providing the banking system time to identify the problems. The problem is that this derivative inspired credit crunch is far too complex for the banks to break down in the time they are likely to be allowed. In addition, most banks and securities houses have no idea of their real exposure, (but you can bet that they are hoping that the worst of it is in the hands of the clownish pension fund managers and other institutional investors)!
As for those that are worried about the fat cats, get over it, why do you think that hedge fund managers are buying £40million houses in London and the likes of Blackstone are finally inviting people to take equity stakes in their cash machines? They have taken their bite at the apple while it was still fresh and juicy and have converted some of their ill-gotten gains into real assets. The brown core of the apple will be left for the rest to fight over.

  • 74.
  • At 02:10 PM on 16 Aug 2007,
  • David C wrote:

Good article, and interesting following comments.

I don't like Government / State Bank intervention in markets. Sometimes it works and masks the cracks, but that only stems the fault lines for so long and can't hold off the big earthquake.

People win and people lose on their own decisions. It's not right for the state to reward bad investment decisions.

  • 75.
  • At 11:13 AM on 17 Aug 2007,
  • Oliver Dungey wrote:

I do not understand how sub prime lending if it consisits as we are told of americans unable to meet their mortgage repayments, how many are there? should be so catastrophic for lending institutions who can and do repossess the lenders properties and recoup a large proportion of the debt. I guess you'll tell me that this is too naive and possibly explain to me how a relatively small problem has been magnified by complex dealing in hedge funds into such a large one

  • 76.
  • At 11:10 AM on 19 Aug 2007,
  • andrew wrote:

And what of the 600+ billion USD of uncertified mortgages taken out by people in the UK since 2000, the vast majority of which are salaried not the self-employed these products were designed for.

It is simply a vast number of mortgages based on false statements of income. International finance isn't going to go near such debts. The mortgage providers won't be able to offer these products anymore. The high house prices that are propped up by these mortges will fall rapidly. These debts will become poison as many home owners in large negative equity positions take advantage of the UK's current banruptcy laws. The UK government simply cann't afford to cover the losses. Bang goes the market.

  • 77.
  • At 02:31 PM on 12 Oct 2007,
  • chris brown wrote:

20;20 vision is wonderful, but the complacency and absolute belief in the Anglo Saxon economic model, implicit in this smug attack on the ECB, is breathtaking!

To quote:

"The big fact is that the Bank of England dispensed precisely zero pounds on propping up the City through the turmoil, compared with spectacular sums made available to banks by the ECB.

That means one of two things.

Either the problems at continental banks are significantly greater than for British based ones. Or the ECB simply did not have enough hard fact on the health of European institutions and panicked.

Whichever turns out to be the case, it suggests that risk-controls at continental banks are inadequate and regulatory oversight is lamentable".

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