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BOHICA, Pt. II: A VERY Scary Story

Com­ment: BOHICA is a mil­i­tary slang acronym for “Bend Over, Here It Comes Again!” A very dis­turb­ing sto­ry regard­ing the euro zone cri­sis was fea­tured in The Wall Street Jour­nal. It looks like the short-term lend­ing to a lot of Euro­pean banks is dry­ing up...this is the kiss of death to finan­cial insti­tu­tions in today’s econ­o­my.  A huge source of financ­ing for the kind of invest­ing banks do involves the “com­mer­cial paper” mar­ket of short-term cor­po­rate debt. That gets con­stant­ly rolled-over (say, once a month or so), and once short-term lend­ing to banks dries up, those banks can be utter­ly screwed.  As the arti­cle points out, it was a dry up of short-term lend­ing that great­ly con­tributed to the 2008 finan­cial cri­sis.

It was dry­ing up short term fund­ing that also helped implode Rhineland Fund­ing and Rhine­bridge Fund­ing, the Ger­man state-owned bank sub­sidiaries that oper­at­ed in the US by bor­row­ing short term from US pen­sions and munic­i­pal­i­ties and invest­ing that mon­ey in sub­prime mort­gage-backed secu­ri­ties.

The arti­cle also notes that a reduced appetite of banks and oth­er finan­cial insti­tu­tions to engage in short term lend­ing with each oth­er has a cas­cad­ing effect of increas­ing inter­est rates on cor­po­rate and res­i­den­tial loans.  So this is just a real­ly bad sign all around AND it’s hap­pen­ing in the wake of the mas­sive euro zone bailout pack­age.  Looks like anoth­er mega cri­sis is com­ing.

“Euro­pean Bank Lenders? Coali­tion of Unwill­ing” by Mark Gon­gloff, David Enrich And Sara Schae­fer Munoz; The Wall Street Jour­nal; 5/26/2010.

Lenders to the major Euro­pean banks are grow­ing increas­ing­ly cau­tious, demand­ing high­er rates for short­er peri­ods, adding fur­ther stress to an already frag­ile finan­cial sys­tem.

Wor­ries about sov­er­eign debt have caused banks and oth­er investors to pare risk. At the same time, new restric­tions on mon­ey-mar­ket funds, which are big lenders to the banks, are forc­ing them to pull back on their lend­ing.

This fund­ing squeeze has already con­tributed to the recent sharp declines in stock, com­mod­i­ty and cor­po­rate bond prices around the world. Unchecked, it threat­ens a repeat of the sort of con­ta­gion that gripped cred­it mar­kets in 2008. [Ital­ics are mine–D.E.]

To avoid such an out­come, the Fed may con­sid­er reduc­ing the inter­est rate it charges on U.S. dol­lar loans it extends to the Euro­pean Cen­tral Bank. The ECB in turn could ease terms on its loans to Euro­pean banks.

The Lon­don Inter­bank Offered Rate, which tracks the amount banks charge each oth­er to bor­row, rose on Tues­day to 0.53625, a 10-month high. The Libor increase is a key sign of banks’ wari­ness.

Lend­ing rates in the com­mer­cial-paper mar­ket, where banks and oth­er com­pa­nies get short-term fund­ing, fol­lowed suit. Euro­pean 30-day com­mer­cial-paper rates for top-tier bor­row­ers rose on Tues­day to 0.48%, the high­est since last Novem­ber, accord­ing to Tim Back­shall, chief strate­gist at Cred­it Deriv­a­tives Research, up from about 0.3% at the begin­ning of April.

Spain’s Ban­co Bil­bao Viz­caya Argen­taria, or BBVA, has been unable to renew rough­ly $1 bil­lion of short-term fund­ing in the U.S. com­mer­cial-paper mar­ket since the begin­ning of the month, accord­ing to peo­ple famil­iar with the mat­ter. The bank still has sub­stan­tial Euro­pean-based fund­ing and deposits and about $9 bil­lion in U.S. com­mer­cial paper. [Ital­ics are mine–D.E.]
With investors increas­ing­ly finicky about cred­it risk, the range of inter­est rates Euro­pean banks are pay­ing for three-month com­mer­cial paper is three to four times wider than usu­al, accord­ing to Amitabh Aro­ra, head of U.S. rates strat­e­gy at Cit­i­group Inc.

Ordi­nar­i­ly, the rates paid by issuers of com­mer­cial paper vary by 0.15 to 0.2 per­cent­age point. This week, he said, the vari­a­tion is more like 0.6 to 0.7 point.

Investors are also “unwill­ing” to lend for more than one month with­out being com­pen­sat­ed more than usu­al, Citi’s Mr. Aro­ra said. Libor rates are 0.35% for one month, but 0.54% for three months and 0.76% for six months.

Dur­ing the past few weeks, sev­er­al U.S. banks and mon­ey man­agers said they have reduced their lend­ing to Euro­pean bor­row­ers.

“Obvi­ous­ly with con­di­tions in the euro-zone as they are, peo­ple will be respon­sive,” said David Glocke, man­ag­er of $150 bil­lion in tax­able mon­ey-mar­ket fund assets for Van­guard Group. “We’ve tak­en a sec­ond and third look at our expo­sures over there and adjust­ed our port­fo­lio where appro­pri­ate.”

U.S. mon­ey-mar­ket fund man­agers, which com­bined have some $3 tril­lion in assets, aren’t nec­es­sar­i­ly sell­ing Euro­pean debt. But giv­en their impor­tance in the mar­ket for short-term cor­po­rate lend­ing, only mod­est changes in buy­ing behav­ior can lead to mar­ket upheavals. [Ital­ics are mine–D.E.]

Mon­ey-mar­ket fund man­agers try to buy rel­a­tive­ly safe assets and hold them for a short time. A mon­ey-mar­ket pan­ic in 2008 con­tributed to the broad­er squeeze in cor­po­rate cred­it. . . .

In an effort to pre­vent anoth­er such cri­sis, the Secu­ri­ties and Exchange Com­mis­sion is requir­ing mon­ey funds to hold more-liq­uid and high­er-qual­i­ty assets, effec­tive Fri­day.

The new rules will short­en the max­i­mum weight­ed aver­age matu­ri­ty of a fund’s port­fo­lio to 60 days from 90 days. Funds also will have to main­tain a min­i­mum of 10% of assets in secu­ri­ties that mature in one day and 30% in secu­ri­ties that mature in one week.

That means funds will have less appetite for longer-term com­mer­cial paper, push­ing up the rates banks must pay to bor­row at longer matu­ri­ties.

This devel­op­ment comes at a par­tic­u­lar­ly bad time for banks, with reg­u­la­tors push­ing them to bor­row at longer rates, to reduce their reliance on short-term financ­ing sources and avoid blow-ups.

Bor­row­ing costs are still well below their lev­els at the worst of the 2008 cri­sis. But short-term fund­ing pres­sures were a key com­po­nent of that cri­sis and can feed on them­selves if unchecked. The sit­u­a­tion has par­al­lels to 2008, when the col­lapse of Lehman Broth­ers caused mar­kets to freeze around the world.

A major con­trac­tion of bank fund­ing could have far-reach­ing con­se­quences. [Ital­ics are mine–D.E.] . . . .


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