U.S: How can the Fed avoid a "credit run"?
Fri, Aug 17 2007, 16:44 GMT
by Carsten Valgreen
- Liquidity provisions by Fed and other central banks have, so far, failed to calm markets. Instead, financial markets remain stressed and dislocated. Hence, it is no wonder many are calling for Fed cuts, to restore “normality” in the markets.
- In many ways this crisis is a close parallel to the 1998 LTCM credit crisis. But the lesson learned by the Fed back then was that Fed cuts worked in the short term but contributed to the notion of a “Greenspan put” in the longer run.
- We think there are other interesting venues that the Fed could explore before cutting rates. One way to deal with the situation is to widen the list of assets eligible as collateral in the discount window. This would broaden the channel through which the Fed is able to provide liquidity to the financial sys-tem.
- The signal and the effect of such type of action will in our opinion be just as strong as a rate cut, as it effectively shows that the Fed is willing to deliver liquidity on all assets it takes, to restore the well functioning of markets. Of course if this doesn’t work, rate cuts will be on the agenda. But the Fed will not tread down this road lightly.
