Interest cuts coordinated – but stockmarket does not rebound

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.

Advertisements

Leave a comment

Filed under Economics

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s