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.
