Central banks launch co-ordinated rate cut
Central banks around the world announced a co-ordinated cut in interest rates on Wednesday, in response to mounting fears about the impact of the financial crisis on the world economy.
The US Federal Reserve, the European Central Bank, the Bank of England, and the central banks of Canada, Switzerland and Sweden all cut their main lending rates by 0.5 percentage points.
German and UK government bonds fell sharply on the news. In London, shares initially rose, but then drifted lower, and at 12.30 local time the FTSE 100-share index was down about 0.7 per cent on the day.
Again, this is all about saving Wall Street and the City: the current crisis was created by too much cheap debt - how on earth will more cheap debt help solve that?
Lending to the real economy is not constrained because it is too expensive to borrow money, but because banks don't want to take on any additional risk (even good risk) because they realize they are carrying too much of the wrong kind and need to reduce that - and thus the price for risk (the risk premium) has skyrocketed.
Interest rates have 3 components, in fact:
- the cost of money (set, ultimately, by the central banks)
- the cost of liquidity (or the risk on other banks, which is skyrocketing)
- the cost of actual transaction risk (which hasn't changed much for good counterparties, but has also skyrocketed for the toxic stuff)
The first one was too low for too long, and has led to excessive lending, ie excessive risks beign taken (and, symetrically, much too low prices set for the third component of interest rates). Now the second component iss going up as banks realize they've gorged on garbage (ie they mispriced the third) and have put themselves at risk.
Bringing the first one down, as the central banks did today, is not the solution to the crisis, which is all about items 2 and 3.
It's too late now for purely psychological measures (morale-boosting) - the issue is no longer one of confidence, but one of actual solvency and rejection of the risks that were taken until recently, with good reason:
Housing Pain Gauge: Nearly 1 in 6 Owners 'Under Water'
More Defaults and Foreclosures Are Likely as Borrowers With Greater Debt Than Value in Their Homes Are Put in a Tight Spot
The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults -- the very misfortune that touched off the credit crisis last year.
The result of homeowners being "under water" is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.
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About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody's Economy.com.
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Among people who bought within the past five years, it's worse: 29% are under water on their mortgages, according to an estimate by real-estate Web site Zillow.com.
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Among mortgages on one- to four-family homes, 9.16% were a month or more overdue or were in foreclosure in the second quarter, according to the Mortgage Bankers Association. That compared with 6.52% a year before and was the highest level since the association began such surveys 39 years ago.
No amount of cheap funding is going to make it possible to avoid facing the stark reality of assets (housing or financial) worth less than they were paid for: the losses will need to be borne.
Financial pain in the real economy will ultimately translate into more pain for banks; whereas help to banks right now is most unlikely to turn into relief for those households that are under water, or for businesses that need money to keep on functioning.
But we're not yet at the stage where solutions are sought: we're still at the stage when friends of politicians (ie the financiers) are being protected - temporarily - from their mistakes.
But that just goes on to show what the political system is geared for.
inspired by the discussion in this diary