Do Central Banks' Extraordinary Measures Reveal Their Fears for 2008?

Seventy-five billion dollars in subprime-related losses have been actualized but there seems to be no bottom in sight. So many are speculating what the final losses could be. No one seems to know, numbers like 2 trillion dollars have been floating around. Besides the U.S. banks such as Bear Stearns (BSC), Citigroup (C), Merrill Lynch (MER), Morgan Stanley (MS), JPMorgan Chase (JPM), Bank of America (BAC), the losses have reached around the globe. The losses have pummeled U.K.-based Northern Rock, HSBC and Barclays (BCS) and even bizarre financial groups such as a Japanese fishing community bank. Most recently the credit contagion pounded Swiss-based UBS (UBS), one of Europe's largest banks, which last week stunned world credit markets by announcing a $10 billion subprime hit.

Complicating the situation is the fact that market participants do not know how much subprime toxic waste or toxic CDOs, CLOS, CMOs each bank holds. They are thus reluctant to lend to each other.

This is the CRUX OF THE PROBLEM!

This is why last week we witnessed the largest coordinated operation under taken by central banks including the European Central Bank [ECB] and the Bank of England, since the immediate aftermath of the 9/11 attacks.

The Fed announced that it will auction $20 billion in 28-day funds and another $20 billion in 35-day funds in two tranches last week. Two more Fed auctions are planned for January. Meanwhile, the Fed has agreed to enter into currency-swap arrangements totaling $24 billion with the Swiss central bank and the ECB, both of which will then hold their own dollar-denominated auctions to further enhance dollar liquidity.

Policy-makers must believe times are desperate. Cutting a full percentage point off the Federal Funds Rate has not seemed to have stemmed the tide of fear. These exceptional actions are being taken because banks have become increasingly disinclined to lend to each other, and even more reluctant to lend for more extended periods, such as three months.

We are facing a liquidity squeeze!

The current credit crisis of course is not just limited to banks. The fear and panic has manifested in the commercial paper markets. Since around 2002, there has been on average, less than a quarter-point spread between high-quality - AA -and lower-quality - A2/P2 - companies. However, this has soared recently to nearly 1.5 percentage points. The scary thing is that this is significantly higher than it was in the days following 9/11. Now combine this with major banks taking cash infusions from sovereign nation funds such as Citi with the Abu Dhabi group.

One can only speculate about what surprises 2008 might bring to the world economies. What we have witnessed so far in 2007 might only just be the beginning of anxious times fraught with great uncertainty and risks. Have the central banks shown their concerns by their exceptional actions for desparate times in 2008?

Comments

[User 129866]

good commentary, when would you recommend buying citi shares?

[User 129866]

good commentary, when would you recommend buying into citi? thanks

[AndrewAbraham]

I believe the banks need to take their losses which they have not done yet... It is not unthinkable that many of the financial institutions we know today might not be around in several years... but there will be tremendous oppurtunities after this capitulation.. I believe one needs to be patiently prudent... thanks

[TheShadow_115]

Given that the dire possibilities you discuss are widely known and have been for weeks if not months? How do you account for the fact that the markets have not already collapsed? The markets, generally very reliable barometers of the financial future, seem to be taking the credit "crisis" relatively calmly. Why? What is the market seeing that you're not seeing?
Isn't this the real question people should be analyzing a this point?

[jpowalski]

I'm buying the fear. These bank stocks, particularly Barclays, are an exceptional value right now. See you in 2011.

[AndrewAbraham]

Who says the market needs to collapse... in 1973-1974...the markets grinded down with intermintent strong rallies destroying equity...as well anything is possible the markets can rally...but the underlying issues need to be addressed and until that happens only more uncertainty and volatility will be present...all I suggest...is have a plan... how to exit with a profit... or know when to take a loss when the trade does not work...