Crescenzi: Central Bank Action is Back Door Easing

“The coordinated actions by the Federal Reserve and other central banks is aimed at the funding strains faced by European banks in what was becoming a modern day run on the banks. The run has differed from the run that George Bailey watched as he drove up to the Bailey Building and Loan in It’s a Wonderful Life, but it has been a run nonetheless. The world in fact has been playing a game of hot potato with European bank debt as well as European sovereign debt, and the only player with oven mitts to hold the hot potato is the world’s central banks.

Illustrating the run on European banks is the sharp reduction in exposures by U.S. institutional prime money funds to European banks. For years the prime money funds invested about 50% of their investable money in European banks. This lasted until June. Since then, data from Fitch indicate the tally has fallen to 35%.

Further evidence of strain has been in the inter-bank market, in particularLIBOR  . Whereas in June the 3-month LIBOR hovered close to the 0.25% rate the Fed pays on excess bank reserves, it was today at 0.53%, indicating banks were having increased difficulty obtaining dollar funding. Moreover, forward rates on LIBOR were priced for 3-month LIBOR to eventually reach about 85 basis points and the trend was accelerating.”

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