Friday, 7 September 2007

What money market?

The term 'money market' is pretty unhelpful in current conditions. There isn't one. There is a short term Libor market, which is decidedly interesting at the moment, and a short term govy market, which is awash with liquidity at least in some currencies. These two markets have decoupled.

The FT, reporting on a speech by Axel Weber, president of the Bundesbank, says:

[...] the tools that modern central banks possess to address liquidity problems can only directly address such runs inside the traditional banking sector, and do not directly touch the non-bank financial sector, which has been hardest hit by the current credit crisis.

Mr Weber’s analysis highlights the dilemma facing central banks, which cannot channel funds directly to the non-bank financial sector, and may therefore have to resort to easing monetary policy instead.

Once the Libor market disassociates from the govy market, there isn't much that a central bank can do. They control financial operations in the govy market, and they can inject extra liquidity there via accepting a broader range of collateral at the window, cutting rates, or whatever. But they have no power over the Libor market. They can hope that if the differential between the two markets becomes large enough banks will step in, borrow from the central bank, and lend into the Libor market, but they can't force that to happen.

Weber claims that the current situation is like a run on a bank, but one effecting conduits and SIVs rather than banks per se. In that these vehicles are suffering a liquidity squeeze that they are vulnerable to due to mismatched funding, I'd agree. But Weber says this "is a total over-reaction". I'm not so sure. If you can get Libor plus 100 for lending a AAA Libor-based funder cash (because cash is really scarce and you have it) why wouldn't you?

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