ECB attacks global liquidity squeeze -- Will it help you?
December 19, 2007
The European Central Bank (ECB) attacked the global liquidity squeeze by flooding the financial markets with €348.6 billion ($502 bn) in two-week loans to member banks at a discounted rate of 4.21%. The two-week Euro LIBOR rate dropped to 4.4% in response, which is exactly what the ECB intended. (Source: FT.com, Investors stunned by ECB's €350 bn, 12/19/07; Barron's What's to Be Scared Of?, 12/19/07)
Central banks around the world have been adding liquidity since August to reassure financial markets who are fearful of loaning to each other. (See Central banks add global liquidity, 8/15/07)
What caused the global liquidity squeeze:
Banks became unwilling to loan to each other in the overnight markets because they are afraid that they won't be repaid. No one knows who is holding how much bad debt that is a result of:
- The collapse of the leveraged buyout (LBO) market.
- The potential $11 billion loss to European banks from bad investments in U.S. real estate loans.
- Fears that the $1.9 billion lost to investors from the collapse of various hedge funds was only the tip of the iceberg.
Central banks had been tightening credit to forestall inflation. Interest rates in Europe are now higher than in the U.S., thanks to continued ECB and Bank of England credit tightening.
Most experts say that Asia will not be as affected by the U.S. subprime mortgage mess as Europe. However, Asian countries rely heavily on exports to the U.S., and investments from U.S. companies and banks. If money dries up in the U.S., this will affect Asian economies.
Action Steps:
The central bank actions are buying time until the financial markets sort out this mess. The global stock markets are suffering in response. Hopefully, you have already moved any money you need in the short-term to a money market account, as I suggested in June (See Trade surpluses driving asset bubbles, 6/27/07).
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