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A perfect example of one of these fallacies recently exposed is the widespread report in August that the
Fed had "injected" billions of dollars worth of "money" into the "system" by "buying" "sub-prime mortgages."
In fact, all it did was offer to stave off the immediate illegality of many banks' operations
by lending money against the collateral of guaranteed mortgages,
but only temporarily under contracts that oblige the banks to buy them back within 1 to 30 days.
The typical duration is 3 days.

Prechter, August 30 2007

The European Central Bank will lend banks 96.9 billion euros ($141 billion)
as some financial institutions try to lock in cash at a record low interest rate.
Bloomberg Dec. 16 2009

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ECB policy rates are now at 3.75%, and it was not even the most important decision the ECB took yesterday.
That was to make unlimited funds available to the banking system at the new repo rate.
In terms of liquidity policy, this is the nuclear option.
The ECB is now providing banks with unlimited funds of 3.75%.

Illiquidity can no longer be a reason for a bank to get into difficulty. Whatever problems we are seeing now, they will be do to insolvency.
Eurointelligence 9.10.2008

The solution to this crisis will have to come from governments.
The two most promising strands were government recapitalisation of the banking sector through preference shares, and a temporary public sector insurance for the inter-banking market.
Britain, not the euro area, has been a leading proponent of both ideas.

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Central banks on Monday added $330 billion to the funds they can pump into money markets as more financial institutions ran into trouble in Europe and the U.S.
WSJ 29/9 2008

The U.S. Federal Reserve said it boosted its currency-swap facility, which lets foreign central banks pump dollars into their cash-strapped banking systems, to a total of $620 billion from the previous $290 billion.

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“The reasons why the massive liquidity injections and policy rate cuts by central banks have miserably failed are clear,”
“We are facing a credit/insolvency problem in addition to a liquidity crunch and central banks’ monetary policy is impotent in dealing with credit problems.”
NOURIEL ROUBINI, November 26th, 2007

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Mostly Spain
Banks becoming addicted to the liquidity window in Frankfurt
Ambrose Evans-Pritchard, Daily Telegraph, 21/8 2008

The ECB, Fed and British bailouts involve a serious problem - repayment.
$540 million (RE: should read billions, I guess),
Martin Hutchinson

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Bank of England's GBP50bn plan
The central bank anticipates that initial take-up of the scheme will total £50bn but there is no cap on lending.
BBC 21/4 2008

Many investors, concerned at what happened to sub-prime mortgages in the US, no longer want UK mortgage-based assets. The disappearance of this market has deprived banks of tens of billions of pounds of finance for mortgage lending.

The BBC's business editor Robert Peston said "This is a banking market bail-out of an ambition we haven't seen in this country since the early 1970's and possibly longer than that,"

In the US, the Federal Reserve took similar action with a $200bn programme to boost liquidity in financial markets last month.

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How well can an economy long characterised by soaring house prices, exploding debt and a dynamic financial sector adjust to a new world?
Martin Wolf, Financial Times May 1 2008

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A plan to loan billions of pounds to British banks is needed to stop the UK's financial crisis worsening, the chancellor has said.
The BBC understands that the Bank will announce the plans to swap about £50bn worth of government bonds for British banks' mortgages.
BBC 20/4 2008

Mr Darling confirmed a scheme to lend banks money to help them operate during the credit squeeze. But he insisted that the loans would have to be paid back.

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Government sponsored enterprises
Capital infusions to date fall far short of prospective losses.
Without new capital, the financial sector will operate with too much risk and leverage
or will put the economy at risk by restricting the flow of credit.
Lawrence Summers, FT March 31, 2008

The policy approach should start with the GSEs. These institutions’ viability with anything like their current operating model depends on the implicit federal guarantee of their several trillion dollars of liabilities. It is appropriate at a time of crisis in the mortgage markets that they become, as their regulator put it last week, the “lender of first, last and every resort”.

It is not appropriate that their shareholders’ “heads I win, tails you lose” bet with the taxpayer be expanded for this purpose.

Given their past and prospective losses, their regulator – supported by the Treasury, the Fed and, if necessary, Congress – should insist that they stop paying dividends and raise capital promptly and substantially as they expand their lending. In the unlikely event that the boards of these institutions refused, policymakers should put them into an appropriate form of administration that insures that their obligations will be met.

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Lawrence Summers

FANNIE MAE and Freddie Mac, the twin titans of America’s mortgage markets, think of themselves as big, friendly giants.
They stand behind the mortgages of around three-quarters of America’s households
The Economist 18/2 2005

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In the end, the Fed can always stop a deflationary spiral.
As Bernanke said to Milton Freidman on his 90th birthday,
the Fed will not repeat the monetary crunch it allowed to happen 1930-32.

"Regarding the Great Depression. You're right, we did it. We're very sorry.
But thanks to you, we won't do it again."
Ambrose Evans-Pritchard on 14 Dec 2007

Hold tight, the central banks have no plan
Last week’s co-ordinated liquidity action by five central banks taught us that this is not the case.
Wolfgang Munchau, FT, December 17 2007

The idea was that a co-ordinated response would reassure the markets, but it had the opposite effect. It turned out that market participants are not infinitely stupid.
They know by now that this is not a liquidity crisis at its core.
If it had been, it would be over by now.

It is a fully fledged solvency crisis that has arisen because two giant and interlinked bubbles burst simultaneously – one in property, one in credit – leaving banks and investors on the brink of bankruptcy

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Efforts ineffective aimed at containing a subprime credit crisis,
not a rapidly spreading prime-credit, solvency crisis
that is leading the U.S. economy into recession.
John Makin January 3, 2008

The good news about the problems in the financial sector and the larger economy in the United States emanating from the persistent drop in house prices is that they will eventually end, and the underlying resiliency of the U.S. economy will reemerge. The bad news about these problems is that they are going to continue for some time and get worse before they improve.

Efforts to address them so far have been ineffective because they have been aimed at containing a subprime credit crisis, not at containing a rapidly spreading prime-credit, solvency crisis that is leading the U.S. economy into recession.

The Treasury has undertaken two efforts to support the financial sector, one aimed at lenders and another aimed at borrowers. The first effort, known as the "Super SIV," was directed at helping banks to organize a $100 billion fund to purchase off-balance-sheet holdings of special investment vehicles (SIV) that were having difficulty obtaining financing in the commercial paper market.

The U.S. housing stock is worth about $23 trillion, so a 15 percent drop in house prices represents a wealth erasure of $3.45 trillion over a period of about two years. That figure represents about a quarter of annual GDP or about 12.5 percent of GDP per year for two years. The total equity capital of U.S. banks, brokers, and finance companies, most of whom are exposed to losses and to levered credit markets tied to falling real estate prices, is barely $1 trillion. While their share of total cumulative real estate losses will be only a fraction of the potential $3.45 trillion in losses that would result from a 15 percent drop in house prices, their share of the losses will certainly impair their capital and thereby their lending ability to a substantial extent.

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Why Do Financial Firms Take Too Much Risk?
John H. Makin, American Enterprise Institute, November 20, 2007

Bubble Trouble
John H. Makin, November 2000

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Prepare for a global economic downturn, but not a meltdown
This is not really a “subprime” or “credit” crisis, as it is frequently called. This is a banking crisis.
Economic history has taught us time and again that banking crises do not simply go away.
Wolfgang Munchau 07.01.2008

What has made it so severe and immune to monetary policy is that financial actors no longer have blind faith in the solvency of their counterparties.

Carl Bildt och den svenska valuta-, bank- och finanskrisen 1992

Wolfgang Munchau

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In past financial crises - the stock market crash of 1987, the aftermath of Russia's default in 1998 - the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn't working.
Why not? Because the problem with the markets isn't just a lack of liquidity
- there's also a fundamental problem of solvency.

Paul Krugman, IHT December 14, 2007

My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia's default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.

In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system - both banks and, probably even more important, nonbank financial institutions - made a lot of loans that are likely to go very, very bad.

First, the United States had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

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Martin Wolf: These are historic moments for the world economy
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This week, the Bank of England and four other central banks in America, Canada, Europe, and Switzerland, injected about £10bn each into the money market.
BBC 14/12 2007

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The central bank helicopters are planning a co-ordinated drop of liquidity on troubled market waters.
One point is clear: central banks must be pretty worried to take such a joint action.
Martin Wolf. FT December 12 2007 18:01

Doomed to Fail
- Central Banks Auctioning of Low Interest Rate Loans to holders of US Mortgaged-Backed Securities

Peter_Schiff, Dec 14, 2007

This week's announcement by the Fed that it will create a new mechanism to provide funding for credit challenged banks has been lauded by Wall Street as an innovative approach to solving the credit crisis. In truth, it is really just the same response the Fed has had for all problems great and small: crank up the printing presses, shower money on the problem, and hope that financial pain can be obscured by the balm of inflation. Both the Fed and Washington politicians are completely clueless regarding the ill effects of the plan, and are simply acting in desperation to keep a ticking time bomb from exploding before the next election.

The Fed and other foreign central banks will provide this liquidity by auctioning low interest rate loans to holders of U.S. mortgaged-backed securities. The loans will be made under the same terms currently in use at the Fed's “discount window”, with the added benefits of even lower interest rates and anonymity (borrowers wish to avoid the public stigma that comes from utilizing the discount window). Since the loans can be collateralized by mortgage-backed securities, the Fed will be on the hook should these loans not be repaid. In other words, the losses will simply be monetized, or more precisely socialized, as they are passed to the public in the form of inflation.

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Paul Tucker, Bank of England head of markets, said:
“We must try to avoid a vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply and slower aggregate demand feed back on each other.”
But the cost of borrowing funds in the European and US money markets remained close to seven-year highs.
In the sterling interbank market, the cost of borrowing three-month money fell to 6.51 per cent from 6.63 per cent, while in the dollar market three-month rates dropped to 4.99 per cent from 5.06 per cent. In the euro market, three-month funding costs barely moved, trading at 4.95 per cent.

Meanwhile it emerged that Alan Greenspan, former chairman of the Federal Reserve, has raised his estimate of the probability that the US will slip into recession from about one in three to closer to one in two, though not actually 50 per cent as reported by some media.

Source: FT 2007-12-14

The unprecedented move is a sign of the severity of the problems

Up to 110 bn dollar in loans will be made available to world money markets by central banks
Analysts say the unprecedented move is a sign of the severity of the problems.
BBC 13/12 2007

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A surprise move by the Bank of England, the US Federal Reserve and three other central banks to inject cash into money markets has had an immediate effect.
The rate at which banks lend to each other fell to 6.514% from 6.627%.
BBC 2007-12-13

There have been fears that if the rate, known as the London Interbank Offered Rate or Libor, remained high then this could lead to slower economic growth.

Seeing its biggest one-day loss since 16 August, the FTSE ended down 3% or 196 points to 6,364, with banks among the biggest fallers.The fall came despite central banks saying on Wednesday they would move again to ease credit availability.
BBC 2007-12-13

Centralbanker samarbetar mot finansiell kris
Linda Öhrn DI 2007-12-13

Flera centralbanker med Fed i spetsen lättar nu på trycket på penningmarknaden genom att tillföra likviditet till bankerna. Beslutet kommer att sänka interbankräntorna, menar bedömare. Federal Reserve, Europeiska Centralbanken, Bank of England, Bank of Canada och schweiziska centralbanken SNB gjorde tunder eftermiddagen gemensam sak för att öka tillgången på kortfristiga krediter på interbankmarknaden.

Krediter kommer att bjudas ut i ett auktionsförfarande som löper över årsskiftet, en tid då behovet av krediter normalt är stort. Vid Federal Reserves två första auktioner är beloppen satta till 20 miljarder dollar vardera. Federal Reserve kommer även att tillgodose behovet av dollar genom att erbjuda 24 miljarder dollar i så kallade swaplinor till europeiska banker.

Jan Häggström som är chefsekonom på Handelsbanken tror att åtgärden kommer att göra det billigare att låna pengar mellan bankerna.
"Det här kommer rimligen att göra att interbankräntorna närmar sig styrräntorna. De har legat mellan 0,5 och 1 procentenheter för högt. Under sådana omständigheter sätter interbankmarknaden käppar i hjulet för centralbankerna", säger han.

Riksbanken välkomnar initiativet från kollegorna i Europa och USA, men ser ingen anledning att följa exemplet.
"I Sverige ser vi idag inte att bankerna har något extra behov av att låna pengar på kort sikt. Vi följer utvecklingen noga och har som alltid beredskap att vidta de åtgärder som krävs om behovet skulle uppstå", säger Riksbankschef Stefan Ingves i en kommentar.


The charge of the central banks
The world’s major central banks have united to take unconventional action in the money markets.
The battle may not yet be won, but the cavalry has arrived.
Financial Times editorial, December 12 2007

When financial markets break down completely a central bank has no choice but to take their place.
The situation is not as extreme as that of Japan in 2001, when the central bank provided almost unlimited sums to the banking system in an effort to increase lending, but it is time to take a step in that direction.

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Charge of the Light Brigade - Wikipedia

The US cavalry arrives, but is it already too late?
The guy in the white Stetson rode to the rescue again yesterday. Alan Greenspan duly gave the financial markets the interest-rate cut they had been counting on
The Independent 21/3 2001

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Why the Fed bailout might not work
The announced plan to make credit markets more liquid could end up having the opposite effect.
Peter Eavis, senior writer, CNN December 13 2007

Before this move, banks could borrow directly from the Fed through the so-called discount window, at 4.75 percent. The key Federal funds rate is lower, at 4.25%, but that is open to a narrower range of financial institutions and accepts a narrower range of collateral than the discount window. The new program - called the Term Auction Facility (TAF) - will auction funds to banks at rates very close to the lower Fed funds rate. The first TAF auction, for $20 billion, is scheduled to begin on Dec. 17.

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Federal Reserve announced it is coordinating with other central banks
to deal with the global credit crunch
The central bank said it had reached an agreement with the European Central Bank as well as the Bank of England, the Bank of Canada and the Swiss National Bank to address what it termed "elevated pressures" in credit markets.
CNN 2007-12-12


They have each announced that they will provide billions in loans to banks
in order to lower interest rates and ease the availability of credit
BBC 2007-12-13


The Fed made the most dramatic changes. It introduced a “term-auction facility” through which all banks eligible to borrow from the discount window could bid for one-month money. The first two auctions are to be held on December 17th and 20th, with $20 billion to be sold at each. Two more are to follow in January. The Fed also announced temporary swap lines with the ECB and the Swiss National Bank, worth $24 billion, allowing those central banks to lend dollars to banks pledging euros or other currencies.
The Economist 2007-12-13

Central banks will now be more intricately involved in the unwinding of the credit mess. Since eligible banks have similar access to the liquidity auction, the central banks are implicitly subsidising weaker banks relative to stronger ones. By broadening the range of acceptable collateral, the central banks are taking more risks onto their balance sheets.
Set against the dangers of all-out financial seizure, these risks seem worth taking.
The Economist 2007-12-13

Varför stoppade ni inte den vansinniga utlåningen?
- Vi hade inte någon glaskula att titta i. Och vi hade blivit utskrattade.
- Det är svårt att vara olyckskorp när allt går som smort, sade en av hans högre medarbetare Stig Danielsson.
Bankinspektionens tidigare chef Hans Löwbeer, intervjuad i Aftonbladet 13/10 1992

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