What just happened?
The world’s major central banks acted jointly on Wednesday to provide cheaper dollar liquidity to starved European banks facing a credit crunch as the eurozone’s sovereign debt crisis threatened to bring financial disaster. The surprise emergency move by the U.S. Federal Reserve, the European Central Bank, the Bank of Japan and the central banks of Britain, Canada and Switzerland recalled coordinated action to steady global markets in the 2008 financial crisis. (via Reuters)
The move makes clear that regulators increasingly are concerned about the strain that the European debt crisis is placing on financial companies, which are facing increasing difficulty in borrowing through normal channels the money that they need to fund their operations and obligations. (via the NYTimes)
Now in English, please.
European banks have been parched for liquidity, and need access to dollars. The ECB can’t supply them dollars unless it borrows them from the Fed. Essentially, today’s action makes it easier for the ECB and thus European banks to borrow dollars. It’s not a solution to the euro crisis by any means; it just means that the most acute liquidity problems will be mitigated for now. (via Business Insider)
Things must have been getting pretty dicey, yes?
Cutting swap costs is the equivalent of interest rate cuts. These banks are now basically providing unlimited U.S. dollars to banks with which to fund themselves. The banks will be hoping this is a turning point in the crisis. We do not know what caused this decision, we may never know, but the smart money is on the fact that yields on one-year German debt went negative this morning (paying Germany to lend it money). This may have been a signal that the money markets were a short shove away from complete collapse. (Jeremy Cook, chief economist at foreign exchange company World First, in the Daily Telegraph)
So the EU debt crisis is pretty much over?
Mohamed El-Erian, chief executive officer of Pimco has his doubts: “This is a dramatic action, to reduce the price and increase the scope of emergency financing, is aimed at addressing growing dislocations in the functioning of financial markets and the increasing fragility of the banking system. Once again, the world’s central banks are being forced to move aggressively to counter a crisis that has grown in scale and scope because of inadequate policy responses on the part of other agencies. As it is essentially a liquidity band aid, it is critical that this coordinated central bank action end up being a bridge to a more effective and holistic policy response.”
So do the guys at RDQ Economics: “These actions (along with the ECB’s reduction in the initial margin for three-month U.S. dollar loans to its counterparties to 12 percent from 20 percent) are intended to lower the cost of U.S. dollar funding but they obviously do not address the underlying cause of the rise in funding costs, particularly for European banks (we use the analogy of these actions acting like tylenol to combat a fever, but the underlying disease that is causing the fever still needs to be addressed). We continue to believe that expanded bond purchases by the ECB will be required to temporarily stabilize Eurozone debt markets.”
So what is the bottom line?
Eurozone governments now have a bit more time to figure out how to save the eurozone. Markets are happy because it seems the ball is moving forward. But without deep structural reforms in at-risk economies, the ECB probably won’t act. As Paul Ashworth, U.S. economist at Capital Economics, puts it, “This is a very helpful move. The markets clearly love it and liquidity is half the battle. But there is still a broader question to be resolved about solvency. If Italy defaults on its debt tomorrow, it wouldn’t matter how much liquidity you had.”