Archive for November 19th, 2008

Bank of England could have reduced rates by 200 bps!

November 19, 2008

In its previous meeting on 6 Nov 2008, BoE had cut rates by a shocking 150 bps making it the largest rate cut in UK’s monetary policy history and also the largest cut amidst central banks (barring Iceland). The markets had expected 50-100 bps. All eyes weer on the minutes of the meeting,

The minutes have been released and suggest that it could have been a 200 bps rate cut!!

The projections in the Inflation Report implied that a very significant reduction in Bank Rate – possibly in excess of 200 basis points – might be required in order to meet the inflation target in the medium term. However, a number of arguments were discussed for not moving Bank Rate by the full extent implied by those projections.

There were 4 points which led to a 150 bps rate cut:

First, the projections had used the normal convention that they were based on the Government’s most recent published tax and spending plans.

Second, although the banking measures that had been introduced around the world had restored a degree of stability to the banking system, it was unclear how the supply of broad money and credit to the wider economy would respond.

Third, a key concern was the degree of surprise to financial markets. Too large a surprise could pose upside risks to the inflation target if the resulting depreciation of sterling was excessive.

Fourth, some members thought there was an argument for leaving some of the required policy loosening to the months ahead to support confidence as the economy weakened.

Hence, because of the uncertainty in the economy and need to have some weapons to fight the looming collapse, BOE did not pass a 200 bps rate cut. One can expect similar/steeper rate cuts in the next meeting on 3 & 4 December. It shouldn’t be a surprise.

Has Bank lending in US declined?

November 19, 2008

There was a paper in October 2008 by Minneapolis Fed Economists which said bank lending has not declined and has infact increased. This created quite a stir as all along we have been expecting it to be opposite.  They look at 4 supposed to be facts right now and say they are  myths instead:

  1. Bank lending to nonfinancial corporations and individuals has declined sharply.
  2. Interbank lending is essentially nonexistent.
  3. Commercial paper issuance by nonfinancial corporations has declined sharply, and rates have risen to unprecedented levels.
  4. Banks play a large role in channeling funds from savers to borrowers.

There are 2 papers which look at the Minneapolis Fed paper and both disapprove the findings. One is by Boston Fed economists and other by Victoria Ivashina  and David S. Scharfstein.

Boston Fed paper provides more disaggregated data compared to Minneapolis Fed paper and shows that first three are reality and not myths. On fourth, they say more analysis is needed.

The second paper by Ivashina provides further analysis:

Fact 1: New lending in 2008 was significantly below new lending in 2007, even before the peak period of the financial crisis (August-October 2008)

Fact 2: The decline in new loans accelerated during the financial crisis, falling by 36% in the August-October 2008 period relative to the prior three-month period.

Fact 3: Real investment loans (working capital or general corporate purposes) and restructuring loans (those for M&A, LBOs, and stock repurchases) have decreased to a similar extent.

Fact 4: During the peak period of the financial crisis (August-October 2008), noninvestment- grade loans fell by 50% relative to the prior period, while investment grade loans fell by 19%.

However, Ivashina provides a caveat which is quite interesting and is a further scope for research:

New lending has declined during the financial crisis. However, it remains unclear whether this decline is supply or demand driven. Are banks withholding funding from creditworthy borrowers who need financing? Or are firms cutting investment in response to concerns about the economy, and thus choosing not to borrow?

To address this issue, we are investigating the differences in the way banks have responded to the financial crisis. Have banks with more impaired loan portfolios scaled back their lending more? Likewise, have banks with a larger revolver overhang cut their lending more to protect themselves against the risk of large revolver drawdowns? And, how have banks responded to the credit guarantees and equity infusions that the U.S. government has recently provided?

Loads of research expected on the issue and is going to be very interesting.

What are covered bonds?

November 19, 2008

They have been discussed a lot in blogs and press. I came across a very useful primeron the topic by Chicago Fed Economist Richard J. Rosen.

Assorted Links

November 19, 2008

1. WSJ Blog points worst outlook since depression is possible

2. Fin Prof points to an interview of Ken French

3. FCB on finance jobs

4. CTB says concerns on microfin sector are rising

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