Seamus Coffey: So much for central banks' pact ... we were here before and not so long ago
The European Central Bank headquarters in Frankfurt. Photo: Getty Images
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SIX of the most important central banks from across the world released a statement which began:
'Today, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank are announcing coordinated measures designed to address the continued elevated pressures in U.S. dollar short-term funding markets. These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets. The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures'.
This is just what the central banks did yesterday but the statement above was released on the 18th of September 2008. We have been here before.
In September 2008 the central banks were reacting to the collapse of Lehman Brothers three days earlier. In November 2011 the central banks are trying to get ahead of the curve by acting before a major bank fails.
The statement released yesterday says that action is to “ease strains on the supply of credit to households and businesses and so help foster economic activity.” The action has no such objective. Very little of the liquidity the central banks are making available will find its way to households and businesses. The action is to ensure that a bank does not fail.
Banks may be facing a liquidity crisis but it is not because they have too little cash to advance as loans, it is because they have too little cash to repay deposits. Banks are unwilling to provide liquidity to each other to cover these operations. This is particularly true in Europe where banks are looking around to see who could be the European Lehman Brothers.
The reason the banks won’t lend cash to each other in short-term markets is because their balance sheets are full of assets of questionable quality. In the main these are sovereign bonds but the doubts exist across all assets on banks’ balance sheets.
Already we have seen that banks will be taking a 50pc write down on Greek bonds that they hold. They have until next summer to find the €100bn of capital to be able to absorb these losses. If they cannot do so they will have to be recapitalised by their national governments just as Ireland as done to recapitalise the banks here but as a result of losses on developer and property loans.
If the problem is limited to Greece the banks will have some difficulty but they will survive. As we have seen in the last few weeks all attention has turned to Italy which is on a different scale to Greece. As the principle of private sector haircuts was introduced in Greece, markets are now pricing in the probability that the same will happen in Italy.
The probability is still very low but because of the scale of the potential losses the impact on financial, and in particular banking, markets are much greater. The banks will be recapitalised to cover their losses on Greek bonds but the size of Italy is enough to overwhelm any rescue fund.
Yesterday’s action by central banks was aimed to get cash onto the balance sheets of ailing banks. It did not address the reason why banks are unwilling to lend to each other. The central banks have provided a solution to a liquidity problem but have ignored the solvency problem that is the root of the problems in the first place.
In September 2008 the Irish banks faced a liquidity problem and the blanket guarantee was a useful solution to that problem. Of course the reason our banks couldn’t get cash from other banks was because they were bust.
Europe must address the same problem. European banks are not lending to each other. They are not lending to each other because of the European sovereign debt crisis. Yesterday’s necessary announcement will keep banks open, and that is undoubtedly important, but it is not sufficient to overcome the much wider problems that exist.
Seamus Coffey is a lecturer in economics at UCC and a blogger at http://economic-incentives.blogspot.com
