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Friday, 02 December 2011 00:00
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Liquidity window for Europe banks helps, Dec 9 critical


The decision by leading central banks, including the Fed, to offer dollar liquidity swap arrangements to European banks, and at a lower rate of interest, is vital at a time when, thanks to the heightening crisis in Europe, liquidity is drying up dramatically for European banks. Such inter-currency swap lines have proved very helpful in the past—according to Financial Times, outstanding swaps were $600bn in December 2008, or a fourth of the Fed’s balance sheet. It is for this reason that markets across the world rose when the facility was announced late Wednesday (Dow and Nasdaq by over 4% each and the Hang Seng 5.6%), a cheer that wasn’t dampened by S&P downgrading top US banks or Moody’s putting the subordinate debt of 87 European banks on watch for a possible downgrade later. The fact that this was the first coordinated action by central banks of developed countries since Lehman made markets feel some concrete action may finally take place, more so since the European Central Bank was part of the move. A larger IMF role, with German blessings, is part of this hope.

The cure, however, looks temporary at best since, while providing liquidity to make up for investors who’ve pulled out, it doesn’t address the issue that only Germany can help address—that the European Financial Stability Facility doesn’t have anywhere near the capital it needs since its plans to raise its firepower to ¤1tn hasn’t moved forward. As compared to the ¤250bn of spare funds it has, European banks themselves need at least ¤200bn and Italy/Spain could require another ¤600bn between them.

All eyes are on the December 9 summit in Brussels to see what gets hammered out at this do-or-die summit. Keep in mind that when, in 2009, the Fed announced the results of its stress test, the reason why US banks were able to raise the funds they needed was the Fed’s guarantee that no bank would be allowed to fail. In the case of Europe, for the first time in the last five years, European banks have not been able to raise funds to match their maturing debts—they’ve sold $413bn of bonds this year and are still a third short. Of course, the passage of the Dodd-Frank Act last year means that, should US banks be short of funds again—as is likely to happen once the results of the tougher Fed stress tests are made public—the US also won’t be able to repeat what it could do under TARP. All of which means the global market rally is irrational exuberance.



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