Reserve Banks releasing cash reserves?

[Captain G]

Why are all the Reserve Banks around the world having to release cash reserves to the markets ?? I heard on the ABC news that it's something to do with helping with market/ financial liquidity, but don't understand how it helps or what the purpose is. Is this a serious issue ??

 

[numbercruncher]

Yes another ominous warning that things arnt as rosey as the "experts" would like us to believe!

 

[numbercruncher]

The ECB injected more than 61 billion euros into the market in its second operation in 24 hours.

"(Action by central banks) signalled that a severe credit crunch represents an imminent risk, and a greater one than the market had anticipated," Tullet Prebon said in a note.

http://today.reuters.com/news/articleinvesting.aspx?type=bondsNews&storyID=2007-08-10T104035Z_01_L10129774_RTRIDST_0_MARKETS-GLOBAL-WRAPUP-4.XML&pageNumber=1&imageid=&cap=&sz=13&WTModLoc=InvArt-C1-ArticlePage1

 

[Pommiegranite]

Why are all the Reserve Banks around the world having to release cash reserves to the markets ?? I heard on the ABC news that it's something to do with helping with market/ financial liquidity, but don't understand how it helps or what the purpose is. Is this a serious issue ??

http://www.espionageinfo.com/Ep-Fo/Federal-Reserve-System-United-States.html

The stock market crash of October, 1987, the Asian financial crisis and its aftermath in late 1998, and the terrorist attacks of September, 2001 each presented an occasion in which the U.S. financial system faced challenges, and when consumer faith in the national economy wavered. In each such situation, as well as in less significant crises, the Federal Reserve has gone into action, ensuring monetary liquidity through large balances of available cash; keeping interest rates manageable by extending discount loans to depository institutions; and setting the example of faith in U.S. institutions by purchasing government securities on the open market.

 

[black_bird2]

Every day I lean sooooooo much about what is going on in the background via this forum. I understand that it is me that has to take the responsibility on board whether I believe the 'hype' or not, but I do appreciate the time and efforts of the members of this forum to post - ta

 

[chops_a_must]

Why are all the Reserve Banks around the world having to release cash reserves to the markets ?? I heard on the ABC news that it's something to do with helping with market/ financial liquidity, but don't understand how it helps or what the purpose is. Is this a serious issue ??

Yes.

Usually the IMF forces central banks to release money so that the US banks can close their losing positions and so that they don't have to take responsibility for their actions and can repeat the process in a few years time.

 

[Smurf1976]

Order of events for this cycle (all in my opinion)

1. Major world stock indices top out (late 1999 / early 2000).
2. Markets fall.
3. Central banks pump up the money supply.
4. September 11 terrorist attacks accentuate market falls.
5. Central banks cut rates to very low levels and undertakes massive monetary expanstion.
6. Stock and real estate prices boom.
7. The Fed (US) and other major central banks commence raising interest rates.
8. Fed stops raising rates. As usual, they've raised them to the point where something breaks. But we don't know what will break yet.
9. US housing market deteriorates.
10. Credit markets strike trouble, beginning with US subprime loans.

11. Major world stock indices top out.
12. Markets fall.
13. Central banks pump...

And so the cycle repeates. End result - we're in for more inflation. It's highly unlikely to be exactly the same as last time, but it ought to be broadly similar. The only question is where it shows up this time, when and in what quantitiy?

 

[jurn]

Why are all the Reserve Banks around the world having to release cash reserves to the markets ?? I heard on the ABC news that it's something to do with helping with market/ financial liquidity, but don't understand how it helps or what the purpose is. Is this a serious issue ??

Hi Captain G,

The response to same question on another board:

http://boards.fool.co.uk/Message.asp?mid=10658472

Jurn

 

[nizar]

Hi Captain G,

The response to same question on another board:

http://boards.fool.co.uk/Message.asp?mid=10658472

Jurn

Top response this one.
Nice and easy to understand.
THanks for posting.

 

[noirua]

I notice the Royal Bank of Scotland, in the UK, pulled a property float for about A$2.6 billion this week.

Banks are having trouble offsetting loans due to lack of liquidity in the markets and Governments are coming to their aid by adding vast sums to shore up a collapse. Banks are now refusing to lend to anyone unless they are considered zero risk.

 

[theasxgorilla]

I notice the Royal Bank of Scotland, in the UK, pulled a property float for about A$2.6 billion this week.

Banks are having trouble offsetting loans due to lack of liquidity in the markets and Governments are coming to their aid by adding vast sums to shore up a collapse.

This is why I dont think people are right when they insist that having record private sector debt but a government with low or no debt means the same thing as the goverment having massive debt. It doesn't. It's Keynesian economics. The Government can and will come to the rescue, to what extent they can will depend on their credit rating.

 

[Sean K]

Top response this one.
Nice and easy to understand.
THanks for posting.

And this would imply that the CBs are very confident that this is a short term liquidity issue and not a longer term problem?

 

[Captain G]

Thanks for all your replies. This is something I never knew Central banks did. So the markets are therefore being artificially supported by the Central banks. This is serious. Like Smurf indicated, can't we just go into a cycle where banks pump in money/ liquidity, and the bigboys buy in, watch the market get saved and then dump?? Also, inflation will have to start going through the roof, for isn't this the same as printing more money etc.

 

[theasxgorilla]

Also, inflation will have to start going through the roof, for isn't this the same as printing more money etc.

Eventually, economic theory suggests that this is what will happen. But inflation is never instant. The time between debt being created and inflation catching up you have a chance to use your debt to create equity and acquire real assets. This is the race that everyone is running...whether they realise it or not.

 

[noirua]

Markets may well steady on Monday. Sometime the Banks outside of America will have to own up to backing sub-prime lending in the US and to a lesser extent in Europe. There have been comments concerning loans and backing given by a major Aussie Bank with a strong profile for lending in the US and Europe, there may be more than one.

 

[dhukka]

Central banks, on a daily basis carry out what are called Open Market Operations (OMO) to help keep the interbank payment system afloat. Consult any High School Economics textbook for a basic rundown.

That is essentially what has just happened only on a much larger scale. The important point to remember is that the central banks are providing liquidity not capital and that liquidity is in the form of debt - not cash.

I recommend you read this article from Michael Shedlock of MGETA if you want to understand what it all means. Below are a few of the more pertinent points:

....there was no brand new money created by these central bank actions. There were, however, huge emergency repos but those are temporary loans. What happened is that banks fearing a need for capital would not lend money to each other like they normally would. This caused overnight rates to shoot sky high.

In the US, the Fed foolishly defends an interest rate target as does the ECB. To defend that interest rate target, repos or reverse repos (draining money) are used to keep the rates where the Fed / ECB wants them. Of course neither the Fed or the ECB has any real idea where interest rates should be and that is one of the reasons we are in the mess we are in.

At any rate, the money (credit really) the hedgies lost is in money (credit) heaven. It wasn't magically brought back by the ECB's or the Fed's open market operations. Those open market operations can help keep the interbank payment system afloat (at least for a while), but it can't persuade any new borrowers to borrow and it can't fix anyone's losses.

Weber: European Central Bank council member Axel Weber said investors shouldn't expect central banks to bail them out in the event of an "abrupt" drop in financial markets. "If you misprice risk, don't come looking to us for liquidity assistance."

The market came looking for "liquidity assistance" and got it in a flash. The Fed's Poole stated matters correctly.

Poole: "The Fed can provide liquidity support but not capital".

And that is what has transpired so far. There was no capital created in these operations, and even had the Fed done a coupon pass (created money), it would have been lent out not handed out.

It is the destruction of credit that is the deflationary phenomenon and that is happening at an increasing pace. It would happen at a far quicker pace if things were marked to market.

Last night the European Central Bank issued a statement promising plenty of liquidity to banks. The Fed arranged a very large $24 bln in repos this morning, trying to get fresh credit in the hands of banks to deal with their current commitments. Even the Bank of Canada issued the same statement.

But all this misses the problem. The theory is flawed. Central banks promising new credit to strapped banks only helps them with their current problems. It will not get new credit into a system that can't take anymore. Banks, given their situation, are reducing drastically their new commitments, as they should. Borrowers can't afford to borrow more.

Sooner or later the market will realize that this is a credit crunch. We have not seen a real credit crunch since 1973. Go back to your history books to witness what a credit crunch does to asset prices. Pure and simple, when the borrowing dries up, there is no "money" to buy assets.

This is a process that is likely to take years to correct. It will not be a pretty process as debt gets destroyed (foreclosures) until enough of these excesses get wiped away to start anew. It was all caused by too-easy credit for too long by a Central bank not willing to let the market itself handle the allocation of capital. It insisted on providing credit cheaply when the market didn't deserve it.

By the way the Fed issued this statement just this morning: The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets.

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding.

The Fed statement today shows there are unusual funding needs. How enlightening. But here are a few things to remember about those funding needs.

* The Fed and ECB can provide liquidity support but not capital.
* That liquidity is primarily needed for prior obligations and prior commitments. As a result you can kiss future growth of IPOs, stock buybacks funded by debt, and mergers and acquisitions, goodbye.
* There is little desire anywhere (globally) to take on more debt or excessive risk.
* As asset prices sink the ability to pay back existing loans is going to get harder and harder.
* Bankruptcies and foreclosures will continue to soar. That's what happens in a liquidity crunch.
* Expect to see lots more hedge funds and lenders blow up too, and not just in the US.

The liquidity crunch is now globally contained.

One last thing: By providing emergency liquidity all the Fed is really doing is defending an interest rate target. It was the Fed defending interest rate targets way back when (say all the way down to 1%) that helped create this mess. If defending interest rate targets is the problem (and it indeed is) then defending interest rate targets cannot be the solution. It's time to abolish the Fed.

 

[numbercruncher]

That is essentially what has just happened only on a much larger scale. The important point to remember is that the central banks are providing liquidity not capital and that liquidity is in the form of debt - not cash.

Id like to add that the ECB injection is not only on a large scale but an all time record, even more than was injected after Sept 11. Which demonstrates the potential severity of this problem.

And yes its good to point out the banks are providing Liquidity, only lending to the system to keep it operational, after all a boat load of money has vanished in a puff of sub prime smoke!

So they arnt adding "more" money to the system just lending some of whats vanished!

 

[Smurf1976]

Thanks for all your replies. This is something I never knew Central banks did. So the markets are therefore being artificially supported by the Central banks. This is serious. Like Smurf indicated, can't we just go into a cycle where banks pump in money/ liquidity, and the bigboys buy in, watch the market get saved and then dump?? Also, inflation will have to start going through the roof, for isn't this the same as printing more money etc.

Note what happened last time. Oil from under $20 to over $70, soaring house prices and more recently rising food prices. Anyone who kept cash in the bank during this period has seen it seriously devalued versus practically anything that isn't either air fares or made in China.

A letter (not written by myself) published in the Mercury newspaper (Tas) yesterday put it fairly well. In 1987 the family purchased a house that cost 2 times the husband's income working for the state government. 20 years later the exact same house costs 7 times the annual income paid of someone doing that same job with the same employer.

Wages clearly haven't kept up as tends to happen during periods of high inflation. Those who held assets free and clear maintained the purchasing power of their capital - they still own the same land, stocks or whatever regardless of their market price. Anyone wanting to buy such assets today is very much worse off.

Historically, inflations tend to be massively popular in the early stages since practically everyone wins. Houses go up, stocks go up, business profits rise and so on. Then they tend to be massively unpopular in the latter stages as more young people get older and seek to purchase houses etc and as price rises filter through to food and other essential daily purchases and the value of savings is effectively destroyed. We're entering that second stage in my view - witness the very public debate over the downside of high house prices, petrol prices and the like. Still should have quite some time to go however until it gets really serious.

 

[saichuen]

Hi Captain G,

The response to same question on another board:

http://boards.fool.co.uk/Message.asp?mid=10658472

Jurn

Top response this one.
Nice and easy to understand.
THanks for posting.

Ditto that! I was actually looking for a simple answer and this is it. Thanks!