The Equity Market - A Side Show

Difficulties with the equity mkt pale when compared to what’s implied by the state of the inter-bank lending market (LIBOR, and readers now know what this is).

As our acquaintance Willem Buiter, Prof at the London School of Economics and (when we knew him) past policy maker at the Bk of England illustrates, "Gordon Brown is absolutely right in his proposal that the G7 offer state guarantees, on ‘commercial’ terms (really terms that provide the state with an adequate risk-adjusted return on the funds it commits) to restore life to interbank lending. Banks today don’t lend to each other without high-grade security at any but the shortest maturities. When banks don’t lend to each other, they don’t lend to the real economy - non-financial businesses and households. That is the road to economic disaster."

Buiter continues, "Large-scale fiscally financed injections of capital into the banking systems of the US and the EU (sans UK) are required immediately. In addition, there is an urgent need for direct interventions in the financial markets, targeted directly at the blockages/distortions preventing these markets from functioning. That means either unsecured lending by the central bank to the banks (i.e. the central bank interposing itself as counter party of last resort in the interbank market) or Treasury guarantees of interbank transactions. The banks participating in the interbank markets are inherently border-crossing institutions. Only if all EU members, the EU orphans (Switzerland, Norway, Iceland), the US, Japan and Canada decide on a common approach to getting interbank lending going again is there a realistic chance of success."

Translation for our friends: Continental European governments, the UK and US authorities better stop hoping for a miracle. Systemically important markets have failed. Now, only the power of the state offers sanctuary. How sad.

Robert Craven