Page 1 of 2 Bernanke running out of ammo
By Julian Delasantellis
A well-worn bit of wisdom from rural America advises one that it is pointless
to "close the barn door after the cows have escaped". By participating in
yesterday's global round of short-term interest rate cuts, US Federal Reserve
chairman Ben Bernanke cannot be said to have been guilty of this offense.
Instead, what he has done is to close the barn door after the cows have
escaped, been captured down the road by cattle rustlers, then sold, slaughtered
and ground up into dog food chunks.
For the 10th time since August, 2007, the Federal Reserve has engineered an
interest rate cut in order to counter the spreading effects of the now global
financial and credit crisis. With twin 50 basis point cuts in both the Discount
Rate, to 1.75%, and the Federal Funds Target Rate, to 1.5%, the Fed has now
just about
emptied its magazine of possible interest rate cuts.
Yesterday's cuts, coordinated across the globe with the Bank of England, the
European Central Bank, the Swiss Central Bank, and the Riksbank of Sweden, with
the Bank of China participating independently with cuts of its own, are the
latest policy initiatives employed by desperate and besieged world economic
officials to contain a truly awesome fire-breathing ogre that goes by the name
of deleveraging, a monster that seems to get worse, and more importantly, laugh
away all attempts to contain it, with every passing day.
It's only natural to characterize the world financial crisis by what's
happening in the world's stockmarkets. Wednesday was one of those days, when
from the moment the sun burst across the horizon in the Western Pacific until
it waned in New York about 21 hours later, there was nothing but pain and
sorrow for those learning the painful lesson that yet another mortal deity
constructed of man, in this case the religion of the God of Money, had failed.
Stocks opened in Tokyo, proceeded to fall by the greatest amount since the
crash of 1987 and stock trading was halted in Indonesia (as it was in Russia,
Ukraine, and Romania) after its benchmark stock index, the Jakarta Composite,
dropped 10% early in the trading day. Most major European indices, even after
the news of the coordinated rate cuts were announced, fell by between 4% and
7%.
In the United States, the Dow Jones Industrial Average, after making a feeble
attempt at a rally in the first hours of trading, was back selling off in the
afternoon, closing down a further 189 points. Just since mid-day last Friday,
when Treasury Secretary "Hank" Paulson's bailout plan passed the US House of
Representatives, the Dow has lost 1,500 points, 14%, of its value; just since
September 1, it's off 2,500 points, or just over 21% of its value.
This week marks the first anniversary of the all time high of the Dow, at just
under 14,300. Since then, the market has lost 35% of its value, over 5,000
points, or almost US$9 trillion of investor wealth. For those who like their
karma extra sweet, it is also the first anniversary of the premiere of the Fox
Business Network, specifically established by News Corp chairman Rupert Murdoch
and his consigliore Roger Ailes, to tell the story of American business that
they believed the rest of the financial media were not telling, namely, that
all was right and that the future looked blindingly bright, for the unregulated
private sector that was at the core of American capitalism.
But world equity's trials and tribulations are nothing compared to what's going
on in the credit and short-term debt markets. This, much more than stocks'
travails, was what drove the trembling hands of the central bankers on
Wednesday morning.
If you're an American parent of a child past puberty, or maybe if you're just
an American with a very good memory, you should remember your experiences at
the uniquely American form of young adult socialization called the first
boy/girl dance.
In a brightly lit and decorated middle school gymnasium, you would find the
entirety of that year's class of 11- or 12-year-olds. On one side of the court
would be the boys, all itchy and pimply and fidgety in their first woollen
sports coat, long-sleeve dress-shirt buttoned up to the adam's apple, and a
striped tie, whether real or clip on, around their necks. On the other side of
the court would be the girls, anxious and nervous in their own right, in their
first pair of heels and hose, wearing a party dress, trimmed with frilly lace,
that they were under strict orders not to get dirty.
The adults, parents and teachers, prod the two sides to get together. That was
usually accomplished by means of some brave little fellow crossing the no-man's
land of mid-court to ask a girl to dance. Others follow, and with that the
process of inter-gender acculturation that will culminate in marriage and
family has commenced.
What's going today in the financial markets is like watching a tape of a
boy/girl dance in reverse. Substitute boys for borrowers and girls for lenders,
or vice versa. When the dance is in full flower, the boys/lenders are
interacting with the girls/borrowers, and everybody's happy. However, run the
dance backwards, and the results are a lot more problematical. Gradually you'll
see fewer and fewer dancers on the floor, fewer and fewer interactions between
borrowers and lenders. At the end of the backward-run tape, you see the two
sides completely separate and alienated from each other - exactly the way the
short-term credit markets are today.
From the sunup in Asia to sundown in New York of every business day, a
multi-trillion dollar dance is conducted of short-term borrowing and lending, a
key component of which is called the commercial paper market.
Say an aircraft manufacturer is receiving payment for a new aircraft delivery,
but does not have to make payments for payroll or for raw materials for new
aircraft until next week. In the system that was fully functioning until about
10 days ago, the company, acting through an investment bank, could invest,
could "buy�, short-term interest-bearing debt of other banks called
commercial paper. A company that had a similar short-term funding need could
issue, could "sell" commercial paper for the duration of its shortage.
In essence, this process cuts out the role of the commercial banks, since the
buyers of commercial paper receive a higher interest rate in this market than
they would from the banks, and the sellers borrow more cheaply than what the
banks would charge.
So when short-term instruments such as commercial paper can't get sold, it's
like the air that the real economy depends on to breathe is getting sucked out.
Even in the face of now sometimes daily multi-hundred billion dollar world
central bank infusions in the short-term money markets, banks are hoarding what
short-term reserves they have - it's not going back out into the commercial
paper market.
This explains the incredible drop in yield of short-term interest rates,
sometimes to under 0.25%, on US government guaranteed one-month Treasury bills.
Even for a loan whose term may only be a few days or less, the brevity of the
loan matters little if the borrower is not around, has declared bankruptcy,
when the paper is due to be repaid.
Conversely, the demand for short-term still funding exists, even as the
potential supply evaporates. The demand for money raises its price; interest
rates are the price of money. The various interest rates that determine the
health of the short term money market, namely, the London Interbank Offered
Rate (LIBOR) and the Federal Funds Market Rate (as opposed to the rate at which
the Fed wants these transactions to occur at, the Target Rate) are all trading
well above where their historical relationships with other market rates say
they should be. LIBOR, in particular, on grim days now sometimes trades higher
than it was last year, although the US Fed has cut rates, including today,
3.75% since then.
Since late April, the Federal Funds Target rate has been at 2%, but on many
days during the month-long financial pandemonium we know call September, 2008,
it traded significantly above that rate, past 4% or more. Getting that rate
down has been the core goal of the massive fire hose of liquidity, probably now
closing in on $1 trillion by now, that the Fed and other central banks have
poured on the money markets these past few weeks.
But if they could barely keep the Funds Rate at 2% after putting a trillion
dollars in the fight, how much less likely is it that they're now going to be
able to keep it even lower, at 1.5%?
Matter of confidence
But what Wednesday's co-ordinated rate cuts could do is to restore a bit of
confidence in the markets. Don't knock that; when Bernanke and Co had a chance
to do that in mid-September they took a pass, and a whole lot of the world
financial system's pain can be traced to events that soon followed that
decision, the decision they reversed today.
In September, following the no-cut decision of the previous day, I noted how
Bernanke's decision had seemed to ignore the developing crisis of confidence
and solvency in the financial markets (see
Ben first, economy second, Asia Times Online, September 18, 2008).
"A Fed rate cut might not have done much; it might have only bolstered
confidence a bit, but, to paraphrase Jackie DeShannon's 1965 pop song 'what the
world needs now is love', what the financial system needs now is confidence,
sweet confidence - it's the only thing that there's just too little of ... "
But on that day the Fed said no. Then came the Paulson Plan, the 12-day
legislative kerfuffle over its passage, at the end of
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