Money Market `Plagued’ by Libor That Fed Can’t Reduce

August 10, 2008 by · Leave a Comment
Filed under: Economic News 

A year after central banks started to pump trillions of dollars into the financial system to end a seizure in credit markets caused by subprime mortgages, cash is about as tight as it’s ever been.

The U.S. market for commercial paper, or short-term IOUs, backed by assets such as mortgages has shrunk 40 percent from its peak in July 2007. The amount borrowed in pounds between banks in the U.K. fell by 70 percent in June from a record in February 2007. The European Central Bank received $100 billion of bids for the $25 billion it offered to financial institutions on July 29, the most since the sales began in December.

Efforts by the Federal Reserve, ECB and Swiss National Bank to shore up the world’s biggest banks and promote lending have had limited success. The London interbank offered rate, the basis for at least $150 trillion of financial products, is within 0.06 percent of the highest since November 1999 compared with the Fed’s benchmark interest rate. The largest financial companies have lost almost $500 billion from subprime-linked securities.

“The key issue that has plagued money markets is the continued high level of borrowing rates,” said George Goncalves, chief Treasury and agency debt strategist in New York at Morgan Stanley, the second-biggest U.S. securities firm. “This time last year no one could have imagined the levels they are at now. We’ve seen a fundamental re-assessment of risk in this new world of tighter credit.”

`Significant’ Premiums

The premiums banks charge each other for three-month cash relative to the overnight indexed swap rate, an indirect measure of the availability of funds in the money market, rose to 77 basis points by 12:21 p.m. in New York, from 10 basis points on July 31, 2007, before the credit crunch began. A basis point is 0.01 percentage point.

“Money markets are quite clearly still in a pretty bad way and that’s not going to change in the foreseeable future,” said Jan Misch, a money-market trader in Stuttgart at Landesbank Baden-Wuerttemberg, Germany’s biggest state-owned bank. “Banks are having to pay significant premiums to borrow cash.”

Credit markets seized up a year ago as banks suddenly became wary of lending to each other because BNP Paribas SA halted withdrawals from three investment funds on Aug. 9 after the French bank couldn’t value their holdings of securities linked to U.S. subprime mortgages. That same day the ECB made the unprecedented move of offering unlimited cash as losses spread.

Collateralized Debt Obligations

Securities firms are only now realizing how little the securities are worth. Last week, New York-based Merrill Lynch & Co. said it sold collateralized debt obligations with a face value of $30.6 billion for 22 cents on the dollar.

CDOs are securities that package pools of bonds and loans and divide their cash flow into notes of varying risk and returns.

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