Wednesday, December 12, 2007

How bad is the credit crisis?

One day after the Federal Reserve lowers the Fed funds rate, we have a coordinated policy move across major Western central banks in the US, Canada, UK, Swiss, and the ECB. This was unanticipated though the Fed has been talking about their concerns with liquidity over the end of the year. 

Banks have been reluctant to borrow from the Fed and LIBOR market rates have continued to stay high in spite of the declines in interest rates by central banks In the US, UK, and Canada. The Fed states that its action will be monetary neutral, but that does not seem likely. What really seems to be going on is that central banks are afraid that if the Fed continues to push rates lower without some coordination there will be a further dollar sell-off. 

The process of one bank lowering rates and others waiting to see what happens has not worked. The idea that some banks can hold the line on rates while others become more accommodating is also not working. An issue is whether we will see more coordination on the credit crisis and the dollar decline. Coordination will force more money into G7 economies which may cause further speculative problems in real estate outside of the US. Coordinating the lowering of interest rates or extending credit in G7 countries will do nothing to solve the global imbalance problem. We also wonder what the Fed may know about bank balance sheets that the rest of the market does not know or has not discounted.

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