On Wednesday morning, at the gleaming headquarters of the Financial Services
Authority in London’s Canary Wharf, the men who will determine whether
Britain’s economy can emerge unscathed from the crisis in financial markets
met to review the situation.
Paul Tucker, the Bank of England’s executive director responsible for markets,
led a team of Bank officials. Sir Cal-lum McCarthy, chairman of the FSA, and
Hector Sants, its recently-appointed chief executive, led for the hosts.
Facing them were senior figures from the top banks, including Stephen Green,
HSBC’s executive chairman, Johnny Cameron, chief executive for corporate
markets at Royal Bank of Scotland, Bob Diamond, chief executive of Bar-clays
Capital, Eric Daniels, chief executive at Lloyds TSB, and Lindsay Mackay,
HBOS’s head of treasury.
In the exchanges that followed, the agenda was clear. The Bank and the FSA
wanted to know how serious the liquidity squeeze was and what the likely
knock-on effects were for the real economy.
“The Bank is watching the situation very closely,” said one senior banker
present. “What nobody knows is how this will feed into the real economy. No
bank will escape a hit but I doubt that it will be a mega number that will
blow a hole in the balance sheet. The real issue is over liquidity and
whether some bank will be short and create a run on the institution.”
For the banks, the issue was whether the Bank of England would follow the
European Central Bank (ECB) and Federal Reserve and help ease the crisis by
pumping in liquidity. Diamond last week contrasted the Bank’s tactics with
the “thoughtful moves” by the ECB and Fed.
Later that morning, the Bank announced it would supply up to £4.4 billion of
extra liquidity to the markets for the next three weeks, in order to get the
overnight rate in the money markets, which had risen sharply, down to
something near the 5.75% Bank rate.
But the move, given only a muted welcome, failed to address the banks’
concerns about the three-month interbank rate. The so-called Libor (London
interbank offered rate) acts as the base for much of the lending in the
economy. It had also risen, to more than a percentage point above Bank rate,
touching 6.9%. But the Bank said it could do nothing about this. “These
measures are not intended, nor can be expected, to narrow the spreads
between anticipated policy rates and the rates at which commercial banks can
borrow from one another – for example, the three-month interbank rate,” it
said.
Critics say the Bank is inflicting unnecessary pain and damaging London’s
reputation. “A lot of people on the trading floors have been saying that it
is too little and too late, especially if you compare it to the actions of
other central banks in the past month,” said one investment-bank economist.
Another senior strategist agreed. “People do not feel the measures they have
taken are going to significantly change the situation,” he said. “The longer
the money markets remain stretched the greater the risk it will impact the
economy.”
Willem Sels, head of credit strategy at Dresdner Kleinwort, called on the Bank
to show a greater sense of urgency. “Mon-ey-market stability needs to return
as soon as possible,” he said. “Central banks need to continue to inject
liquidity and the Fed will need to cut. The market needs to believe that
they will do everything to support the banking sector. This needs to be done
quickly. September is a dangerous month.”
Not everyone thinks the complaints are justified. The Bank’s supporters say
there is little difference in the gap between three-month money market rates
and so-called policy rates (Bank rate and the Fed funds rate) in Britain and
America, suggesting the Bank’s tactics of supplying only limited liquidity
are not to blame.
“The long-term credibility of the Bank is at stake if they bail out careless
lenders and greedy investors,” said Alan Wilde, deputy head of fixed income
at Barings Asset Management.
A senior fund manager said: “The Bank has been right to be careful and not
make a knee-jerk reaction just because investment banks are squealing about
deals that have gone wrong.”
But while the credit crunch persists, the recriminations may have to wait. One
legacy of the crisis sparked off by the American sub-prime lending fiasco is
that a huge amount of commercial paper – market IOUs – that nobody much
wants has to be “rolled over” or refinanced. This week alone, some $113
billion of such paper has to be rolled over. In the short-term, the
consequences could be another sharp spike in money-market interest rates.
“Asset-backed commercial paper is rolling off every day and the banks are
taking more and more on to their balance sheets, which is using up capital,”
said Paul Mortimer-Lee, global head of market economics at BNP Paribas. “It
is both a liquidity and a capital crisis.”
ON the sunlit shores of lake Como, some of the world’s movers and shakers have
been meeting in recent days at the annual Ambrosetti Forum at Villa d’Este.
A kind of late-summer Davos, it usually offers an opportunity for quiet
reflection, a world away from the dealers’ screens and the market frenzy.
On this occasion, though, it provided a forum for more sobering thoughts on
the outlook. On Friday, American figures showed a drop of 4,000 in nonfarm
jobs last month, the first fall for four years, against expectations of a
100,000 rise.
One leading economist said he would be “gobsmacked” if the Fed, under Ben
Bernanke, did not cut the Fed funds rate at its next meeting in nine days.
Alan Greenspan, Bernanke’s predecessor, warned that there were similarities
between the current crisis and the 1987 stock-market crash and 1998
hedge-fund crisis. Many are now looking for a 50 basis-point reduction from
the Fed, which would take the rate down from 5.25% to 4.75%.
Rodrigo de Rato, managing director of the IMF, who was at the lake Como
meeting, said some slowdown in global economic growth was inevitable.
“We now expect some downward revisions to our growth projections, especially
next year,” he said. “The revisions are likely to be largest for the United
States, but we may also see some impact in the euro area. This will have
implications for monetary policy.”
Jim O’Neill, chief economist at Goldman Sachs, who was also at the meeting,
said the prospect was still for a slowing of global growth. “I look at this
situation and I say ‘Thank God for China’,” he said. “We shaded down our US
forecasts some weeks ago. If there was any evidence that things were
starting to go wrong in China, I’d be much more worried.”
The big unknown is the extent to which the credit crisis will affect the real
economy. David Kern, economic adviser to the British Chambers of Commerce,
warned that the slowdown already in prospect for the British economy was
likely to become more severe.
“The increase in interbank rates is in effect a tightening of monetary
policy,” he said. “It is likely to increase the cost and reduce the
availability of money to businesses. This is quite dangerous.”
There is also a new uncertainty in the housing market. According to an
analysis by the Council of Mortgage Lenders, the most seriously affected
lenders will be those who fund their mortgages mainly from the wholesale
markets and hold them in securitised form.
For mortgage borrowers, recent weeks have brought relief from the fear of
further interest-rate rises. But the net effect of the scramble for
liquidity is likely to be that the rise in the cost of borrowing already
seen in Britain’s own sub-prime sector will spread to ordinary mortgages.
Michael Saunders, chief UK economist at Citigroup, warned of the impact of
this on housing. “We expect housing turnover to fall about 20% from recent
levels, and house-price inflation to fall to zero, in the year ahead,” he
said.
Saunders thinks rate cuts will be on the Bank’s agenda in the next three
months if the money-market crisis persists. The game has changed, and nobody
yet knows the result.
BANK’S STEADYING HAND
UNTIL the present crisis blew up, Paul Tucker had two main worries. One was
whether he could rid himself of his reputation as the “uber-hawk” on the
Bank of England’s monetary policy committee. The other was living with the
label “future Bank governor”.
Tucker, 49, joined the Bank 27 years ago, fresh from Trinity College,
Cambridge. Keen to give a rising star broader experience, the Bank lent him
to a merchant bank’s corporate finance department, and then to the Hong Kong
monetary authorities to help sort out the mess after the 1987 stock-market
crash. On his return, he worked as private secretary to Robin
Leigh-Pemberton, Eddie George’s predecessor as governor, during the period
of Britain’s ill-fated membership of the European exchange rate mechanism
(ERM).
In recent months he has no longer been the most hawkish member of the MPC,
ceding that role to Tim Besley and Andrew Sentance. But, as the Bank’s
executive director for markets, he has found himself at the eye of the
credit storm. Tucker is the Bank’s point man in the markets, responsible for
its operations in the money markets and the currency markets. The crisis
comes only months after he reformed the framework for the Bank’s operations
in the money markets.
Tucker is a City man and recent criticism of the Bank from within the Square
Mile will have hurt. Those who know him say he has dealt with these
criticisms robustly, seeing many of them as misplaced, and has been keen
that the Bank’s actions are seen as measured, and not giving the impression
of panic.
He also believes it is not the Bank’s job to protect “unwise lenders from the
consequences of their past decisions”.
The next few weeks will determine whether he has got it right.
