Liquidity crises? Here's US$ 154 bn. - Views on News from Equitymaster

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Liquidity crises? Here's US$ 154 bn.

Aug 10, 2007

The European Central Bank (ECB) yesterday announced that it would release 'unlimited' cash at a 'bargain' rate of 4% from its coffers to full the 'malnourished' European banks, which are facing a liquidity scarcity owing to the subprime crisis. And the US Federal Reserve added another US$ 24 bn as temporary reserves to the banking system. Feathers ruffled, pain inflicted
The ECB reacted to the cash crunch that European banks are facing as a fallout of the sub-prime crisis. The sub-prime crisis has dried up liquidity in the global financial markets as concerns of a contagion has spread far and wide. Following this cash deficit, the London inter-bank lending rate (interest rate at which a bank borrows/lends money from/to other banks) shot up from 5.35% to 5.86%. And, as reported by Forbes, 49 banks duly accepted the offer by absorbing US$ 130 bn released by the ECB. Now, that sounds similar to a reaction to 'sale' at a shopping centre!

In the meanwhile, the sub-prime crisis continues to take its toll on the financial biggies. In a 'reputation hurting' move yesterday, BNP Paribas, the largest bank in France, has 'blocked' redemptions from two of its funds that are worth Euro 2 bn (US$ 2.7 bn). In a statement released to its investors, the fund has indicated - "The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating. The situation is such that it is no longer possible to value fairly the underlying US ABS (asset backed securites) assets in the three above-mentioned funds. We are therefore unable to calculate a reliable net asset value for the funds. In order to protect the interests and ensure the equal treatment of our investors, during these exceptional times, BNP Paribas Investment Partners has decided to temporarily suspend the calculation of the net asset value as well as subscriptions/redemptions."

While the bank goes on to state that the valuation of these funds and the redemption process will resume as soon as liquidity returns to the market allowing NAV to be calculated, the failure of so many funds from some of the global financial giants (remember Bear Sterns), raises the question as to what damage will the sub-prime crisis inflict on the global economy and financial markets. And this uncertainty continues to take toll on global equity markets - sell-off in stocks was seen yesterday in the US and Europe, and the Asian indices are all in the red currently. Hong Kong, Japan And Singapore are down 3% each.

What next?
The release of additional cash at specific rates to the banking system in not a new phenomenon and central banks resort to such tactics to deal with liquidity crises. However, what is really concerning is the way the contagion seems to be spreading across markets. The inflation in asset prices over the past 3-4 years has been largely a result of high levels of liquidity induced by cheap money globally. Now, with money drying out as investors become apprehensive and holding their funds tight (or investing in the rather safe government treasuries), the global financial markets are being witness to incresing levels of risk.

The ECB move, which has otheriwse been undertaken to soothe the banking system of its liquidity worries, can very well backfire and actually create a crisis of confidence. Definitely, risks are rising!

  • What to make of this global crisis - Ajit Dayal

    What to do?
    Keeping your head while everyone around you is losing their's! What else can you, as a long-term investor do in these heady times? The pain of a global unwinding might hit Indian equities hard for the short term. However, this can very well provide your with the opportunity to invest keeping in mind that long term Indian story remains intact.

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