open Democracy News Analysis - Why the banks are hoarding cash, Tony Curzon Price - Comments

opendemocracy on "Why the banks are hoarding cash"

opendemocracy — Thu, 30 Oct 2008 22:04:22 +0000

Ganesh, I want to post on the Fed's credit line to Brazil, Mexico, Singapore and Korea. This is very significant, and there is a great post on it by Brad Setser, here.

One of the many surprises of the crisis is that demand for dollars is very high. Partly this is because a lot of the liabilities that are being insured against are dollar denominated. Another is that dollar government bonds appear safer than most other stores of value -- in large part because the American taxpayer and the American economy can be called on to repay US Federal bonds.

Tony

Ganesh Trichur on "Why the banks are hoarding cash"

Ganesh Trichur — Thu, 30 Oct 2008 19:24:36 +0000

Why are interest rates dropping so low? Is it to tempt banks to start re-lending? To whom? For what purposes?
Interest rates in the US are currently at 1%. Price argues that the Credit Default Swaps (CDS) that banks have been practicing are largely unregulated and outside of the bailout scheme. Hence banks are reluctant to lend even though interest rates are at historical lows.
Perhaps another reason for the low interest rates is that no one wants to borrow US dollars! As the FT notes today, the Fed wants to lend $30 billion to Brazil, Mexico, South Korea and Singapore. It will be interesting to see who else competes to buy dollars. But given the historically low interest rates is this not a "liquidity trap" of the kind Keynes wrote about in 1936? In short what is there to prevent interest rates in the near future from rising to speculatively high levels (from their already too low levels)? In which case all those who borrow US dollars today will find that they have to repay at higher interest costs. Is this not part of the real dilemma of the dollar today?
Ganesh Trichur

Why the banks are hoarding cash, Tony Curzon Price

Tony Curzon Price — Thu, 30 Oct 2008 09:49:50 +0000

The BoE quarterly report has a table (reproduced below) of all the measures that have been taken by central banks world-wide to get banks lending again. The fact that, after all we are doing, they still are keeping all the cash they can get their hands on for themselves, shows that their difficulties are much worse than these solutions envisaged. I have written several times about the Credit Default Swap market, and here is a really insightful article (hat tip Eurointelligence) describing exaclty how the "CDS overhang" (or should that be hang-over?) is causing a sort of financial black hole into which any cash that comes into the orbit of a bank gets whooshed.

What the article makes clear is that taxpayer funds and guarantees -- worldwide amounting about £4.5 trillion -- do not cover the losses that banks are exposed to on their unregulated CDS dealings. A CDS is just an insurance contract: a bank agrees to pay out some stated amount if some specified loan (bond) goes bad. Banks, hedge funds and insurance companies found they could sell thisinsurance in large quatities -- far larger than the value of the loans being insured. In the casino on which the sun never set --- our modern financial markets --- there was a market in bets on other people's ability to pay, whether you had a stake in the game or not. There are $50 trillion of outstanding CDS contracts. It is fear of these liabilities that is making banks cash-hoarders.

But liabilities may well be capped below the $50 trillion number. When Lehman's was bankrupted, institutions that had insured Lehman bonds had to find cash to pay out on the insurance. CDS's are non-regulated, non-standardised, 'over the counter' (OTC) products and come with a wide variety of terms. According to the article, some of the CDS's required that the insured party deliver the underlying debt in order to get paid. This limits the size of the CDS payout overhang. Unsurprisingly, insurers have been asking for delivery of Lehman debt before paying out. It will be interesting to see if the price of bankrupted Lehman bonds starts to move up.