Friday, August 10, 2007

Financial Times Editorial Comment: The markets need clarity and calm

Financial Times Editorial Comment: The markets need clarity and calm
Copyright The Financial Times Limited 2007
Published: August 9 2007 18:31 | Last updated: August 9 2007 18:31

Thursday’s spike in the cost of borrowing euros, dollars or sterling overnight takes the current round of credit turmoil into a new phase. There is now the risk of a real financial crisis, with banks forced to sell assets because they cannot borrow cash. Their underlying problem is losses and illiquidity in markets for asset-backed securities, but if central banks provide liquidity to compensate, and if banks and regulators move quickly to clarify the extent of losses, there is no need for panic.

In the midst of Thursday’s tumult the European Central Bank felt it had to offer unlimited short-term loans to the money market, distributing €94.8bn, but while the ECB provided the banking system with extra cash it did not cut interest rates. The ECB, like the Federal Reserve and the Bank of England, clearly sees a financial problem rather than a shortage of credit in the real economy.

An important question is why interest rates spiked and why the ECB felt it had to intervene. A generalised loss of market confidence should be easy to stabilise, but if the market has got wind of a specific problem at a large bank then the situation is more dangerous.

Thursday’s suspension of three BNP Paribas funds stuffed full of structured debt matters little. It will be painful for retail investors in the funds, but any eventual losses will be contained by the funds’ capital.

The drip, drip, drip of ABS losses at European banks such as NIBC of the Netherlands and IKB of Germany is more serious. Nobody knows how big the losses are, or who will be affected next, creating credit risks in the money market.

The real problem, though, is the complete standstill in the ABS market, which means banks cannot securitise new assets or offload any ABS they hold. Banks are also being forced to lend to asset-backed funds such as IKB’s Rhineland Funding when investors refuse to roll over their commercial paper.

What is needed first is clarity. With clarity on ABS losses it will be possible to lend with comfort, so banks should update both markets and regulators on their holdings and possible losses. It is unacceptable that IKB’s position is still not clear more than a week after news of that crisis broke.

What is needed even more, however, is calm. Based on what we know today, there is no reason to think any big financial institution is in danger. Central banks should provide short-term liquidity as needed but should not be panicked into interest rate cuts. Investors, meanwhile, will gain nothing from a disorderly stampede for the exits.


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