Ever the Scrooge, the Bank of England appeared to offer a lifeline to beleaguered money markets yesterday only to tell them that actually it wasn't a lifeline at all and please don't ask for any more. Nor should you call this an emergency loan, for all that is being provided is what the framework on open markets operations allows for anyway.
Throughout the crisis, the Bank has adopted the view that this is essentially a problem of the markets' own making and it is therefore incumbent on the markets to sort it out. Even if it could do something, it would not be minded to except in circumstances where there was a threat to the wider economy. To take precipitous action might be only to further panic the markets.
Instead, the Old Lady has taken to reminding the banks of what is available under a 15-month-old framework governing its position as lender of last resort. One avenue of relief is the so-called standing facility, allowing banks to borrow overnight whenever they want at a penalty rate of interest. By raising the reserves they deposit with the Bank of England, banks also gain greater access to funds at base rate. It was use of this latter facility that drew all the attention yesterday.
Rather surprisingly, the banks collectively posted only a 6 per cent increase in their monthly demands. Helpfully, the Bank of England said they could increase this by a further 25 per cent next week should they wish. Yet it is not in the overnight money markets, where the interbank rate is close to the base rate of lending anyway, that the problems lie. Rather it is in term, or three-month, rates. Hoarding of money by individual banks against the possibility that they might need it for their own purposes has caused term rates to shoot up to historic highs.
The problem applies not just to Britain, but to Europe and the US too, where, taking account of interest rate expectations, the spike in the cost of three-month money is roughly equivalent. The ECB has attempted to address the problem by providing three-month money at its target rate, but to virtually no effect. Its actions have failed to encourage banks to start lending to one another again.
The Bank's approach in refusing to engage therefore looks about right. Even if it were minded to help, it would likely be a pointless endeavour.
All the same, the limited steps taken yesterday may end up being more helpful in kickstarting the system than the Bank cares to admit. If banks can borrow with impunity overnight at non-penalty interest rates, they should eventually feel happier about lending to each other further out.
Could the Bank have done more to unglue the system? The separation of banking supervision, responsibility for which now lies with the Financial Services Authority, from the Bank's overall responsibility for financial stability has diminished the Old Lady's authority in the City as well as its ability to knock heads together in a crisis.
Yet whether the Governor's eyebrows would continue to work in today's global capital markets even if he were in a position to exercise them is open to question. The deference among bankers that lay at the heart of the old system of governance is long gone, and, in any case, wasn't notably successful in dealing with banking crises even when it existed.
Curious incident of dog that didn't bark
It's a bit late now. In time-honoured fashion, Moody's, the credit rating agency, yesterday announced that, in light of events, it was adapting its methodology for rating so-called "Structured Investment Vehicles" (SIVs), the arcane credit investment funds which lie at the heart of the present crisis in debt markets.
As a result, another raft of them was downgraded to junk or put on notice of it. Thanks a lot, guys. Just before these previously unheard-of beasts leapt from the window ledge, most of them were rated triple-A. Now that, splat, they have hit the pavement, they are formally being pronounced dead. More absurdly still, the rating agencies apparently need a new methodology to come to this conclusion.
This is how Moody's described these vehicles in a 78-page tome on the sector just three years ago. "SIVs were founded in the late 1980s in response to investor demand for steady returns on capital and highly rated portfolios that are immunised against substantial downgrades, interest rates, currency and liquidity risks." Immunised against downgrades? Well I never.
It is perhaps unfair to mock, but the SIVs and their close relatives, the SIV-lites and banking conduits, were an accident waiting to happen if ever there was one. Few outside the rating agencies and the money markets took any notice of them before the proverbial hit the fan. This in itself is another lesson in why it pays to analyse the financial markets' more arcane innovations. Off balance sheet and unregulated, they went almost entirely ignored.
According to Moody's, there are 30 SIVs and six SIV-lites in existence, collectively accounting for roughly $400bn of assets. These assets are largely made up of the dreaded mortgage-backed securities which have so put the frighteners on markets. The SIVs may sound complicated and obscure, but in fact their business and purpose is relatively simple. The crisis that now besets them conforms to the pattern of banking crises down the ages.
The business of banking is essentially about borrowing cheaply and short from those who have money and lending it more expensively longer term to those who need it. When the depositors lose faith in the use their money has been put to the system breaks down. Depositors demand their money back and the bank cannot deliver. These events used to be called a run on the bank. Modern solvency regulation is meant to prevent their historically devastating consequences.
Yet this is basically what has happened with SIVs, which are at route just money-making devices for borrowing short, lending long and, hopefully, pocketing the difference. As US subprime mortgages went into meltdown, investors lost confidence in mortgage-backed securities. They became impossible to price and therefore to sell. This in turn has caused banks and other financial institutions to stop lending to the SIVs, making it impossible for the SIVs to refinance their debt as it falls due.
As Moody's pointed out, there have in fact been virtually no downgrades on the underlying assets and no defaults. Yet you can hardly blame investors for mistrusting these reassurances given what has happened to SIVs.
On one level, the whole meltdown is in fact little more than a crisis in confidence. The reason why the banks have stopped lending term money to one another is not because they think Barclays or Royal Bank of Scotland are about to go bust, but because banks have all begun to hoard what liquidity they have for the strong likelihood that they will be called on to refinance their sponsored SIVs and conduits (a conduit is similar to a SIV but is run directly for the benefit of the sponsoring bank).
Loss of confidence in higher risk forms of debt has separately caused some $400bn of finance for already transacted private equity deals to get stuck in the system. Do the banks take an immediate haircut on this debt by selling it at a discount, or do they take the debt permanently on to their own books?
Whatever the decision, it is no longer sustainable for the banks to insist that this is no more than a temporary liquidity problem that will eventually go away. As bank share prices already correctly anticipate, there are going to be big write-offs and losses associated with the present repricing of credit risk. Fat balance sheets and otherwise healthy profits should mean that the damage won't proportionately be as bad as in previous banking cycles, but nor will it be small enough to sweep under the carpet.
Never mind the failings of the credit rating agencies, one question for financial regulators as they sift through the wreckage is why SIVs and vehicles like them were so easily allowed to escape the regulatory net. Their curtailment will remove another source of easy money for the banks, further undermining profits.