FYI | Oct 03 2007
By Greg Peel
It’s now over two weeks since the Bank of England halted the run on Northern Rock and the US Fed slashed its interest rate. As to whether the Northern Rock experience encouraged the Fed to go that one step further and cut by 50 basis points is not specifically known, but what is known is that up until there were riots in the streets the BoE had steadfastly refused to bail out the British banking system by injecting liquidity. Every other major central bank had been quick to move.
The BoE was forced to turn to the Chancellor of the Exchequer in desperation to guarantee Northern Rock deposits should the panic spread to other regional British banks. The Chancellor responded by guaranteeing all British bank deposits, an unprecedented move which prompted GaveKal analysts to suggest the global credit crunch ended right there and then.
Certainly the response from global stock markets over the past two weeks suggests most investors are happy to believe we’ve put the uncertainty of the credit crunch behind us, and a tentative return to business in prime lending and a pull back of credit spreads corroborates that view. However, we’re not out of the woods yet.
Yesterday the management of Australia’s RAMS Home Loans (RHG) averted what clearly must have been developing into an untenable situation and sold off the only valuable parts of its business to Westpac Bank (WBC). RAMS’ share price has since fallen over 45%, trading this afternoon at 50c which is 5c below what had earlier been deemed by analysts to be the salvage value of RAMS’ business. That is no longer the case with the distribution network about to be sold and the brand name lost. At least RAMS’ management and employees get to keep their jobs.
After the Northern Rock debacle the Bank of England finally began pumping liquidity into the British banking system and, as other central banks had moved to do much earlier, it expanded the range of repos it would accept. However, an approach to the BoE for assistance does not come with a guarantee of anonymity, and the current British cash rate is 5.75%. Just across the Channel, British banks can gorge themselves on free flowing European Central Bank liquidity with the security of non-disclosure, and enjoy the ECB target rate of 4.00%. All they need for qualification is a European branch. The London Daily Telegraph reports:
“EU sources say Britain’s banks have been clamouring for money in Frankfurt, accounting for a substantial chunk of the E190 billion (L132 billion) lent last week in the ECB’s variable tender operation. ‘It is fair to say they have been borrowing from the ECB on a very large scale. It’s cheap, so why not?’ said one official.”
The Telegraph also notes UK banks were shouldering each other in the queue for the E50 billion issue of three-month loans at 4.63% on September 27, and also at an earlier E75 billion tender on September 13. This goes a long way to explaining why the pound shot up against the euro in early September, in the middle of a liquidity crisis.
Hans Redecker, head of currency trading at France’s Bank Paribas, suggested “The money markets may look as if they are functioning again in Britain, but in reality they are not.”
Apart from the cheaper European funds, the UK banks are terrified of exposure, and subsequent runs on their own funds and share prices. The BoE has promised not to publish names but no one can underestimate nor trust the British press. Can’t think why not. The German press has already exposed Barclays as a major player at ECB auctions. Barclays has declined to comment.
There are 1,676 banks registered in the Eurozone, according to the Telegraph (Northern Rock is not one of them). As they all suckle on ECB credit it makes it hard for the stoic BoE to discipline them for their trespasses. London has criticised Frankfurt for its laxity, while Frankfurt has accused London of allowing a problem to turn into a disaster.
Tomorrow night both the BoE and the ECB make rate decisions. The BoE has to be a very good chance to cut, as much as it would grate on them. Under the circumstances, an ECB cut is not a given.
