Posts Tagged ‘stock market’
If liquidity is a problem in the economy, then a cut in interest rates is a good idea. A coordinated move by six central banks made a cut of 0.5% today – a surprise in the UK where the decision was thought to be made on Thursday when the Bank of England’s monetary policy committee was due to meet. The question though is why did this take so long in coming – this was an obvious first step to take, which could be done quicker than injecting money back into the system. It would have been a signal to the market that central bankers were taking concerns over an economic downturn seriously.
However stock markets are still falling – the FTSE falling by 5% today, the Dax by nearly 6% and Dow Jones at the moment a modest 0.16% gain. Bankers are looking for governments to step in to buy shares, to help market capitalisation – effectively so that they have the funds for the financial system. The domino effect on business and consumers is very real, but the government’s must not write a blank cheque on this. While depositors need to know their funds are secure (to prevent runs on banks), those banking models that put a bank effectively out of business need to be allowed to go under, managed only so that they do not impact on banks which are struggling because of the financial crisis – not due to bad loans. Toxic debt should not be taken completely at face value.
In other major developments:[source BBC News]
- The UK government unveiled a package of measures aimed at rescuing the banking system which could add up to £400bn ($692bn)
- European and US stock markets fell as investors remained unconvinced that the co-ordinated rate cuts and bank rescues would solve the financial crisis.
- All UK savers with accounts in the closed Icelandic internet bank Icesave were told they would get all their money back.
- The Treasury arranged for more than £3bn of UK savers’ money held with Icelandic banks Kaupthing Edge and Heritable Bank to be transferred to ING Direct UK.
- Iceland’s prime minister said he hoped to find a “mutually satisfactory solution” to the loss of UK Icesave deposits after Prime Minister Gordon Brown threatened to sue Iceland to recover the money.
The big interest cuts cuts should have been made sooner. One factor that helps is that it will make the cost of borrowing cheaper. Something which governments with budget deficits need. The only other problem is that with little money going around government borrowing so much will crowd out private sector investment. That however is less of a concern then a banking system that is seized up.
It may seem like socialism to some. Yet there is no need to reward failure or to encourage risky loans. The problem is that the market is usually better at picking winners than governments are. Decisions by central governments have to be done on the basis of what is best for their economy – bringing stability and confidence back into the system. Raising the amount of deposits secured by the state was a positive step.
The question is why it took so long for national governments to act on the levers that they readily had at their disposal. That lack of confidence in handling the credit system crisis is one reason why stock markets are not rallying quickly. The confidence in the world economy is bleak, not helped by a wait and see attitude that for example the UK government has shown on a “case by case” mentality. The government finally announcing measures that make available £400 billion ($692bn) to allow the credit system to flow again as the banks have stopped lending to each other is welcome.
The key points of the plan are:[source BBC News]
- Banks will have to increase their capital by at least £25bn and can borrow from the government to do so.
- An additional £25bn in extra capital will be available in exchange for preference shares.
- £100bn will be available in short-term loans from the Bank of England, on top of an existing loan facility worth £100bn.
- Up to £250bn in loan guarantees will be available at commercial rates to encourage banks to lend to each other.
- To participate in the scheme banks will have to sign up to an FSA agreement on executive pay and dividends.
The failure of macro economic policy lies squarely with elected governments – that enjoyed the good times but did not heed the warning signs till a crisis hit the system. Voters being kicked out of their jobs will have their revenge when election time comes. Much of the pain could have been softened if governments had taken action sooner.
However, when there is more to fear then fear itself and uncertainty that is easy to say. When governments start sending mixed signals the problem of confidence, let alone knowing what is going on with full information, makes rational decision making problematic – adding to the financial crisis.
Ireland guaranteed deposits 100%. This infuriated other member states of the EU, because it put pressure on them to do like wise – exacerbated by capital going to Irish Banks. Yesterday the German Chancellor appeared to state that the government would back savings also by 100%. That is significant – Germany has more savings then any other country. The British Government could not get specifics on the German policy.
If the UK followed suit that would mean guaranteeing funds in excess of a trillion pounds – money which the government does not have. This weekend like last saw bankers loosing time off as a scramble to sure up liquidity and governments buying stakes in banks:
- The German government was forced to salvage a 50bn euro ($69bn; £39bn) rescue package for Hypo Real Estate
- Denmark and Sweden both increased the amount of protection depositors in their banks receive
- Iceland said its banks had agreed to sell some of their overseas assets and was trying to persuade the trade union pension funds to repatriate some of their funds too
- The individual actions came after EU leaders decided at a summit on Saturday not to attempt a pan-European solution
- France’s BNP Paribas said it would take a 75% stake in Fortis. [BBC News]
The worry is domino dancing, with a collapse not just spreading in the banking system in one state but in others as well. In an interdependent world, and single market Europe seems unprepared for quickly speculation is impacting on confidence as they chase after one crisis after another. Rather then providing confidence and stability, this is reacting to events as they unfold.
Before the financial crisis an economic downturn was happening. The situation with banks is going to confound the problem. As well as people and businesses finding it more difficult and costly to get finance there is the added problem. Redundancies are going up and the costs of living are rising. It does matter to us ordinary people on Main Street because what was already a difficult situation is being made worse. There will be less tax payer’s money for public investment – borrowing will be more expensive for the government in these times – and for the type of spending that gets an economy through downturns when the private sector starts delaying investment and scales down production.
As an economist it can be difficult to not sound excited at what is happening. Suddenly everyone is concerned about the economy and what is going on, and what sort of regulation should be in place.When times are good people take it for granted and any muttering of lack of oversight or weaknesses are shouted down as regulation that would strangle the goose that lays the golden egg. The irony as always is such public and government concern and scrutiny of what is going on happens too late when the horse has already bolted.
On that panicked horse are in for a bumpy ride.
Stock markets are once again down suggesting it will take more to calm the beast: