Trichet, King May Support Fed as Ammunition Runs Low
By Simon Kennedy and John Fraher
Federal Reserve Chairman Ben S. Bernanke has so far shouldered most of the burden of saving the global economy and financial markets. He may be about to get more help.
With the credit crisis entering its ninth month, Bank of England Governor Mervyn King and European Central Bank President Jean-Claude Trichet are on the verge of new steps to spur lending and increase liquidity, say economists at Lloyds TSB Group Plc and Royal Bank of Scotland Group Plc. Interest-rate cuts may be next if the crisis persists.
``We're inching closer to the great global monetary easing,'' says Joachim Fels, co-chief economist at Morgan Stanley in London.
Lloyds predicts King's next step will be to accept more types of collateral for loans. Trichet will pump more money into banks, RBS forecasts. Such measures would take Europe's two biggest central banks further down the path laid out by Bernanke this month.
The Fed chairman needs all the help he can get. In addition to lowering interest rates at the fastest pace in two decades, Bernanke has committed as much as 60 percent of the $700 billion in Treasury securities on his balance sheet to expand lending. The Fed has also offered a $29 billion loan against illiquid securities to assist the buyout of failing securities firm Bear Stearns Cos.
``There is a barrier in terms of the size of the Fed's balance sheet as to how much it can do'' short of printing more dollars, says Neil Mackinnon, chief economist at London-based hedge-fund ECU Group Plc, which manages about $1.5 billion. ``If the European central banks were to adopt more Fed-style measures, it would go a long way to helping the Fed tackle the crisis. This is not only a problem for the U.S. to resolve.''
The ECB and Bank of England have so far failed to restore order to money markets. The cost of borrowing in euros and pounds last week rose to highs for the year. The three-month London interbank offered rate for euros climbed 5 basis points to 4.73 percent, the highest level since Dec. 27. It fell today for the first time since March 3, according to the European Banking Federation.
Deutsche Bank AG, Germany's biggest bank, said last week that ``very challenging'' market conditions will make it harder to meet its profit goal. The Bank of England was forced on March 19 to deny speculation that HBOS Plc, the U.K.'s largest mortgage lender, faced a cash shortage as interest rates surged.
By following the Fed's moves to take illiquid securities as collateral and ease credit terms, King and Trichet would confront the same concern Bernanke, 54, already faces: that they're exposing their balance sheets, and ultimately taxpayers, to potential losses on private-sector securities.
Accepting assets that are hard to sell ``raises the question of moral hazard and could be seen as a bailout for financial institutions that took excessive risk,'' says Christine Li, an economist at Moody's Economy.com in London. ``Putting illiquid mortgage-backed securities onto the central bank's balance sheet will transfer a lot of the risk associated with these instruments.''
At the moment, though, King and Trichet are being bashed for too much caution, not too little.
King, 60, has been slowest to act. Former Bank of England policy maker DeAnne Julius, now chairman of research organization Chatham House, faults him for not offering banks as much cash as the Fed or the ECB and for not acting sooner to accept a broader range of asset-backed securities at auctions.
Sitting on Cash
U.K. banks are sitting on cash and refusing to pass on the central bank's rate cuts to customers, pushing mortgage rates to the highest level in more than seven years and further weighing down a housing market that's already the worst in 18 years.
When King told Parliament on March 26 that he is discussing ``longer-term'' solutions to the credit crisis, lawmaker Jim Cousins told him: ``You're losing the battle. People can smell it.'' Speaking in Israel today, King said banks may be pushed to hold more liquid assets and capital in the future.
Kenneth Broux, an economist with Lloyds TSB in London, predicts the bank will start accepting assets backed by mortgages and might cut the penalty rate it charges banks that borrow outside its regular auctions.
``They've been very conservative, but they have to do more,'' Broux says.
Praise for ECB
Trichet's ECB won plaudits for acting quickly at the outset of the crisis last August, when it loaned 94.8 billion euros ($150 billion) to banks after credit markets seized up. The ECB's charter allows it to lend to a wider range of financial institutions than the Fed and to accept more diverse collateral than either the Fed or the Bank of England.
Now the Frankfurt-based bank is showing signs of stepping up its rescue efforts. Last week it allotted 216 billion euros in its regular weekly refinancing operation, 50 billion euros more than it estimated was required, and offered further cash over periods of three and six months. The bank today received bids from 25 banks in a one-day liquidity providing refinancing operation.
Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland, says the ECB may need to become even bolder. Options include cutting the rate at which banks lend to each other overnight. Lena Komileva, head of research at Tullett Prebon Plc in London, predicts the ECB may soon inject bigger amounts into the banking system.
``This is an extremely difficult environment for the ECB,'' she says. ``The current deterioration in liquidity conditions is based on fundamentals and likely to persist.''
Beyond new liquidity efforts lies the prospect of following the Fed's path toward deeper rate cuts -- a step King and Trichet, 65, have been loath to take because of price pressures. The inflation rate in the 15 nations that share the euro is the highest in almost 16 years; it's at a nine-month high in the U.K.
That has kept the ECB's key rate at 4 percent since June, while the Bank of England's, at 5.25 percent, remains the highest among the Group of Seven nations even after two cuts since December. Economists expect the ECB to cut its benchmark rate to 3.5 percent by the end of the year, according to the median of 24 estimates in a Bloomberg News survey. The Bank of England is forecast to cut its main rate to 4.5 percent, according to the median of 15 projections.
Meanwhile, the Fed has already lowered its target overnight rate by 3 percentage points, to 2.25 percent, since August. Unless the gap between the Fed and the European banks narrows, it risks fueling inflation in the U.S., slowing economies elsewhere and causing banks more pain, Deutsche Bank economists said in a March 24 report.
``Stresses in markets have reached new heights,'' the report said. ``The significant difference in the approach to managing what is now a truly global financial crisis could aggravate the problems and cause more severe damage to the world economy.''
That has some analysts predicting that Trichet and King will have to cut rates sooner rather than later: Morgan Stanley's Fels predicts the U.K. central bank will cut in the next quarter, and the ECB will follow later in the year.
``The ECB and BOE have stubbornly refused to cut rates, although extreme stress is visible in European financial and commercial real-estate markets,'' says Michael Shaoul, chief executive officer at New York investment-research firm Oscar Gruss & Son Inc. ``This intransigence is unlikely to last much longer.''