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Monetary and capital markets

Crisis gives central banks no respite

Fri, Apr 18 2008, 14:25 GMT
by La Caixa Economic Research Dept.

La Caixa

The so-called subprime mortgage crisis began in August last year. The origin of the problem was the granting of mortgage loans in the United States to customers with low solvency without having carried out suitable risk controls. These mortgages were securitized and in this way passed on to a wide range of financial agents that were scarcely aware of the risks they were taking on. The sudden increase in default of these products set off a crisis of confidence among financial institutions that brought about restriction on the granting of loans, liquidity problems and heavy losses in balance sheets. The financial upsets, which have respected neither markets nor borders, have continued ever since.

 In the United States, the increase in default and the drop in the capital ratios of banks has meant bank credit is harder to get. In interbank markets, where banks lend to each other, the situation has meant an increase in interest rates. In view of the turn taken by the liquidity crisis, which finally had become a banking crisis, the Federal Reserve, the US central bank, at its meeting on monetary policy on March 18, decided to further cut its reference rate, this time by 75 basis points, to 2.25%. In its press release following that meeting, Fed members underlined the sharp decline in economic activity.

 Before this cut in the official rate, the Fed adopted a series of measures aimed at easing its effects. The ultimate aim of these measures was to increase liquidity, especially in the interbank market and in the market for assets backed by mortgage securities.

 At the beginning of March it created a new «liquidity window» to which US investment banks that had no access to the discount window could apply, as was the case for other deposit-taking banks.

 Secondly, the Federal Reserve decided to accept as collateral or security for that liquidity not only Treasury bonds but also bonds issued by the federal agencies Freddie Mac and Fannie Mae and even mortgage-backed bonds issued by private companies with high credit rating.

 In addition, the Fed announced an increase in swaps with the ECB and the Swiss central bank. A swap of this kind is a financial exchange in which the Fed puts dollars at the disposal of those two central banks so that they may make those dollars available to European commercial banks. In return, the Fed obtains assets in euros.

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Published on  Fri, Apr 18 2008, 14:36 GMT

Archive

• Crisis gives central banks no respite
  Published On Fri, Apr 18 2008, 14:25 GMT
• Central banks faced with a dilemma
  Published On Thu, Nov 22 2007, 15:25 GMT
• Sub-prime mortgage crisis holds market attention
  Published On Wed, Oct 24 2007, 12:34 GMT
• Sub-prime mortgage crisis in United States centre of attention
  Published On Mon, Oct 8 2007, 12:09 GMT
• Upward moves by Bank of England and ECB in offing
  Published On Thu, Jun 7 2007, 09:59 GMT

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